Congress appears poised to revise the law that requires some financial institutions to face stricter oversight as a way of preventing another economic meltdown, says James B. Thomson, Ph.D., chair of the Department of Finance in the College of Business Administration at The University of Akron.
If Congress acts, it could mean some regulatory relief for three regional banks based in Ohio.
At the invitation of Sen. Sherrod Brown D-Ohio, Thomson testified July 16 in Washington before the Senate Banking subcommittee on financial institutions and consumer protection. Brown heads the subcommittee.
'Systemically important'
Under the financial regulation law known as Dodd-Frank, passed in the wake of the 2008 financial crisis, bank holding companies with assets of at least $50 billion are automatically considered to be “systemically important” – that is, their collapse would pose a grave risk to the nation’s economy.
Those banks, along with certain non-bank financial institutions also considered to be systemically important, must comply with additional federal regulations. Compliance has a price tag, which cuts into profits.
The question, Thomson says, is whether $50 billion is an appropriate threshold. He proposes $250 billion, with case-by-case attention to banks smaller than that.
But beyond that, he believes defining systemically important financial institutions by size alone is the wrong approach. The kind of business a bank does, the risks it takes and other factors are better indicators, he says.
Taking a 'Four C’s' approach
Regional banks KeyCorp in Cleveland, Fifth Third in Cincinnati and Huntington in Columbus all have assets of more than $50 billion and by law are considered systemically important. But their business models reflect fairly standard banking activities, Thomson says, so regulating them the same way as banks that make riskier investments serves no purpose.
“If they’re not posing a threat to the financial system,” he says, “then why are you doing that?”
Thomson would like to see regulators give more consideration to factors other than size when assessing an institution’s level of risk. He proposes the “Four C’s” of systemic importance:
- Contagion: If an institution fails, how will its losses spread across the financial system and affect other companies?
- Correlation: Many institutions have portfolios that are very similar. If something bad happens, they all stand to suffer big losses. Regulators should require more detailed reporting of assets to gauge exposure.
- Concentration: The presence of a few big players in a market means that the failure of one would cause a major problem.
- Context/Conditions: When markets are fragile, failing firms are more likely to benefit from political intervention to save them than during more normal market conditions.
Thomson is available to discuss the issues surrounding systemically important financial institutions. Read his subcommittee testimony.
Media contact: Roger Mezger, 330-972-4219 or rmezger@uakron.edu.
James B. Thomson