Are You Systemically Important?

too_big_to_fail_poster

One of the catchphrases that came out of the 2008 financial crisis was “too big to fail.” It’s a great concept, but hard to define in a meaningful way. Many think that there is no private company that should not be allowed to fail. Dodd-Frank created a concept of systemically important, trying to create additional oversight for “financial companies” that could be too big to fail.

The trick was trying to define a “financial company.” Many companies use derivatives to hedge their business risks. Many big manufacturing companies use hedging to limit exposure to commodities they use. Companies with overseas operation use foreign exchange derivatives to hedge currency risks. The tough part was drawing the line.

The Federal Reserve Board on Wednesday announced approval of a final rule that establishes the requirements for determining when a company is “predominantly engaged in financial activities.” The requirements will be used by the Financial Stability Oversight Council when it considers the potential designation of a nonbank financial company for consolidated supervision by the Federal Reserve.

The final rule defines the terms “predominantly engaged in financial activities”, “significant nonbank financial company” and “significant bank holding company.” The FSOC must consider the extent and nature of the company’s transactions and relationships with other significant nonbank financial companies and significant bank holding companies. If designated, those nonbank financial companies will be required to submit reports to the Federal Reserve, the FSOC, and the Federal Deposit Insurance Corporation on the company’s credit exposure to other significant nonbank financial companies and significant bank holding companies as well as the credit exposure of such significant entities to the company. Consistent with the proposal, a firm will be considered significant if it has $50 billion or more in total consolidated assets or has been designated by the FSOC as systemically important.

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