Domestic banking institutions deemed significant can face classification, according to Hsu of OCC's plan
In a recent address, Acting Comptroller of the Currency Michael Hsu outlined a proposed framework for designating systemically important banks (SIBs) in the United States. This framework aims to identify large, interconnected financial institutions whose distress or failure could pose significant risks to the broader financial system.
The proposed designation process involves the use of systemic risk indicators and revised leverage ratios, such as the enhanced supplementary leverage ratio (eSLR), tailored for Global Systemically Important Banks (GSIBs). Quantitative thresholds, like a minimum 3% eSLR, will be set to identify these vital institutions [1][3].
The rationale behind this designation is straightforward. Large and connected financial institutions pose substantial systemic risks. Their failure or perceived weakness can lead to broader market instability by reducing valuations of other firms and decreasing overall market liquidity—even if these banks do not outright fail [2]. Accurate identification of these firms is critical to developing regulatory and supervisory strategies that minimize financial instability and protect the economy.
The proposed framework reflects an evolving regulatory landscape that responds to ongoing financial innovation, consolidation trends, and the critical role large banks play in the U.S. economy and capital markets [4][5].
Hsu drew a parallel between bank supervision and physical exercise for a human body. He emphasized that the impact of a particular examination or information request may be small, but the overall effect over time is significant in promoting safe and sound practices [6].
Hsu also warned against the risk of the supervisory process becoming overly burdensome, stating that it can morph from being a tool into a cage. To prevent this, he advocated for a horizontal "team-of-teams" strategy for bank oversight, organizing teams by specialty rather than by individual bank [7].
Moreover, Hsu highlighted the need to ensure that non-GSIBs don't fall through the cracks of regulation [8]. He argued that smartly cohorting institutions can prevent blind spots and allow a flatter organizational structure to flourish.
Hsu's proposals come amidst a backdrop of increased scrutiny on the banking sector, following the fall of 2022 when the crypto market saw $2 trillion in losses and assorted bankruptcies. Yet, the banking sector saw limited impact, which Hsu attributed to a long ground game of supervision seeking to ensure that crypto activities banks engaged in were safe, sound, and fair [9].
The Office of the Comptroller of the Currency has also realigned its supervision of midsize and community banks by function, not geography [10]. Hsu differentiated regulation from supervision, equating the former to a speed limit and the latter to reinforcement of safe driving [11].
In conclusion, Hsu's proposals emphasize the need for a proactive, risk-based approach to bank supervision, aimed at identifying and mitigating systemic risks, while ensuring that non-GSIBs are not overlooked. The goal is to apply appropriate regulatory measures that mitigate the risks these banks pose, including managing market confidence and preventing contagion effects across the financial system.
The proposed framework for designating systemically important banks (SIBs) could potentially expand to include financial institutions beyond Global Systemically Important Banks (GSIBs), given the inherent risks that the failure or perceived weakness of large and connected financial institutions can pose to the broader financial system. It's essential to ensure that non-GSIBs are precisely identified and regulated, to prevent potential blind spots and to maintain a stable and secure financial environment. As the financial industry continues to evolve through innovation and consolidation, it's crucial to invest in comprehensive and adaptable regulatory strategies that protect the economy, facilitate business growth, and foster a thriving fintech sector.
