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### Preface: context and scope
- Builds on a Technical Note (IMF Country Report No. 10/251) produced as part of the IMF’s 2010 FSAP assessment of the United States.
- FSAP involved two sets of meetings, during October 14–November 3, 2009 and February 17–March 12, 2010.
- Interlocutors included the U.S. Department of the Treasury, Federal Reserve (Fed), Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of the Currency (OCC), Office of Thrift Supervision (OTS), Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC), and Federal Housing Finance Agency.
- Paper reflects discussions and comments from the above bodies; focuses on incumbent regulatory arrangements while acknowledging changes introduced by the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010.
- Emphasizes prerequisites for effective oversight: high-quality information-sharing, coordination, systemic risk analysis, accountability, and clarity of mandates (as highlighted in IMF Country Report Nos. 10/247 and 10/250).

### Executive summary: purpose, view on consolidated supervision, and key recommendation
- Reviews outgoing U.S. consolidated regulatory and supervisory arrangements and retrospects on options to strengthen them.
- Argues group-level regulation and supervision are potent tools of financial sector oversight and key to mitigating systemic risk.
- Notes a very significant share of the U.S. financial system is controlled by a few key holding companies; the “mega-diversified” conglomerates are heterogeneous and systemic, posing a critical supervisory challenge.
- Changes needed (or were): eliminate exceptions for holding companies owning certain limited-purpose banks; harmonize arrangements for bank and thrift holding companies; bring into the net a few systemic nonbank financial groups.
- Fed identified as best placed to bear consolidated supervisory mandate but will need to reallocate resources toward securities and nonbanking operations in large complex conglomerates.

- Box 1 — United States: Key Recommendations on Consolidated Oversight:
  - Organization and location: Establish one, and only one, federal program of consolidated regulation and supervision, grounded in statute and housed at the Fed.
  - Scope: Cover in this program all holding companies that own one or more FDIC-insured depository institutions, regardless of charter type and without exception, plus any other financial firms deemed to be potentially systemic, through selection procedures to be established.
  - Mandate: Give this program the dual mandate of supporting the safety and soundness of the covered groups individually and mitigating any systemic risk they may create collectively.
  - Activity restrictions: Prohibit covered groups from engaging in most commercial activities, and require the Fed to enforce such prohibitions.
  - Prudential norms: Require the Fed, through this program, to impose and enforce prudential requirements at the consolidated level, with a system of mandatory supervisory actions, and to subject the largest and most interconnected of the covered groups to stricter standards.
  - Deference: Authorize the Fed, through this program, to impose additional requirements on any regulated or unregulated subsidiary, with due attention to regulatory differences by type of firm, softening but not eliminating deference requirements vis-à-vis bank and functional regulators.
  - Additional enforcement powers: Vest the Fed, through this program, with additional, discretionary enforcement authorities, up to and including orders to divest business lines or subsidiaries.

### I. Crisis lessons, institutional responses, and systemic-risk framing
- Regulatory and supervisory failures and gaps rank high among causes of the global financial crisis of 2007–09.
- Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 enacted as major post-crisis reform.
- Focus of reforms: better mitigation of systemic risk, defined as the risk that actions of one or several financial intermediaries adversely affect others and the economy.
- Congress established the Financial Stability Oversight Council (FSOC) as the “systemic risk regulator.”
- FSAP team emphasizes a strong role for the Fed as “lead executor” of the FSOC given its monetary policy, lender-of-last-resort duties, and consolidated supervisory authorities over bank holding companies.
- Outgoing system had three federal consolidated supervisors: the Fed, the OTS, and the SEC; paper concurs with Congress that there should be only one consolidated supervisor: the Fed.

### II. Regulation, system structure, and asset-share dynamics
- Federally insured depository institutions are “special” due to public policy privileges: access to Fed standing facilities, settlement through Fedwire Funds Service, discount window borrowing, and FDIC or NCUA deposit insurance.
- Counts and institution types:
  - 6,622 FDIC-insured commercial banks as of end-September 2010.
  - 1,138 FDIC-insured savings institutions as of end-September 2010.
  - 10 FDIC-insured branches of foreign banks in the system as of end-September 2010.
  - 7,445 NCUA-insured credit unions as of end-June.
- Asset-share dynamics:
  - Federally insured depository institutions: share of U.S. financial sector assets fallen from about one-half in 1980 to close to one-fifth currently.
  - Housing GSEs’ share of U.S. financial sector assets doubled from about one-twentieth in 1980 to over one-tenth currently; GSE MBS account for essentially all residential mortgage securitization post-crisis.
  - Shadow banking system’s share increased from about one-tenth in 1980 to about one-quarter currently.
  - ABS pools at pre-crisis peak held over one-fifteenth of U.S. financial sector assets.

### Regulatory perimeter: two concentric circles and entities that straddle them
- Stylized perimeter:
  - Inner ring: depositories and the housing GSEs; subject to intensive, hands-on, safety-and-soundness regulation and supervision, consumer protection, investor protection, and access-to-finance rules.
  - Outer ring: all other types of regulated financial entities (including insurers, real money investors, and many “shadow banks”); regulated for consumer and investor protection but generally not supervised under an explicit safety-and-soundness mandate.
  - Outside the outer ring: certain private pools of capital (e.g., derivative product companies and hedge funds) and instruments (e.g., credit derivatives and “144A” securities marketed only to “qualified institutional buyers”) left entirely unregulated.
- Financial groups often combine entities across rings, creating implicit recourse, operational and reputational risks based on brand and enterprise-level commitments.
- A large share of the U.S. financial system is controlled, in one way or another, by a few key holding companies.

### Shadow banking system vulnerabilities
- Wholesale funding chains rely on repurchase and securities lending with collateral often substituting for counterparty due diligence.
- Money market mutual funds subject to Rule 2a-7 of the Investment Company Act of 1940 but not daily onsite supervision like big wholesale-funded banks.
- Securities broker-dealers and futures commission merchants subject to net liquid assets standard requiring liquid assets to exceed all liabilities.
- Hedge funds largely unregulated; investment advisors often not required to register or report.
- ABS trusts are special-purpose, with no controlling shareholders, opaque portfolios, and liability features (e.g., early amortization) designed to avoid formal events of default.

### Consolidated supervision in the United States: structure and statutory gaps
- Consolidated supervision “peers through” corporate separations to focus on group-level interactions and risk management from the holding company level.
- U.S. consolidated oversight has been bank-centric:
  - All holding companies that own insured depositories are regulated and supervised in principle.
  - BHCs under the Fed since 1956; SLHCs under the OTS since 1967.
  - 4,861 BHCs and 436 SLHCs in the system as of end-September 2010.
  - Statutory oversight for BHCs and SLHCs focused on protecting the safety and soundness of federally insured depositories; “source of strength” doctrine expects holding companies to support insured depository subsidiaries.
- Important statutory exceptions and complexities:
  - Exceptions to BHC status: certain thrifts and limited-purpose banks (ILCs, credit card banks, trust companies, “nonbank banks”) are not deemed banks under the Bank Holding Company Act of 1956; companies that own them are not BHCs and are exempt from Fed oversight.
  - Exceptions to SLHC activity restrictions: grandfathered companies owning a single insured thrift since before the Gramm–Leach–Bliley Act of 1999 are exempt from SLHC activity restrictions (but not OTS oversight); SLHCs have not been subject to any consolidated capital floor.
  - Financial holding company (FHC) construct (GLBA): expanded permissible activities; only BHCs with depository subsidiaries classified as “well-capitalized” and “well-managed” could elect FHC status; Fed as “umbrella supervisor” directed to defer “to the fullest extent possible” to functional regulators.
  - 512 FHCs in the system as of end-September 2010.

### Consolidated supervision of investment banks: SIBHC and CSE programs
- Broker-dealer supervision focuses on customer protection rather than safety-and-soundness; Rule 15c3-1 (the “net capital rule”) aims to protect customers and enable orderly liquidation.
- Two elective consolidated protocols:
  - SIBHC program: GLBA-created broker-dealer holding company with SEC as consolidated supervisor; SEC directed to defer “to the fullest extent possible” to functional regulators. Only one SIBHC existed (Lazard).
  - CSE program: nonstatutory SEC regime adding appendices to Rule 15c3-1 including a value at risk-based “alternative net capital rule” with a Basel capital computation and holding company prudential requirements (including two liquidity standards). All of the “big five” U.S. investment banking groups became CSEs.
- Features and frictions:
  - Neither SIBHC nor CSE imposed activity restrictions.
  - CSE program imposed absolute capital norms: required at least one securities broker-dealer with net capital and “tentative net capital” of not less than $500 million and $1 billion, respectively, and introduced a $5 billion early warning requirement for tentative net capital.
  - CSE recognized Fed consolidated supervision equivalency for FHCs and exempted FHCs from SEC consolidated oversight, but did not extend equivalency with SLHC supervision—three of the “big five” were supervised by both the SEC and the OTS with minimal coordination.

### Crisis outcomes, weaknesses, and legislative responses
- Crisis outcomes for weak points:
  - CSE and SLHC program outcomes included: two CSEs acquired by FHCs (Bear Stearns by JPMorgan Chase and Merrill Lynch by Bank of America); two CSEs converted limited-purpose bank subsidiaries into “regular” commercial banks and became FHCs (Goldman Sachs and Morgan Stanley); one collapsed (Lehman Brothers).
  - Among major SLHCs: one taken over by an FHC (Countrywide by Bank of America); one resolved at no cost to the Deposit Insurance Fund (Washington Mutual, bought by JPMorgan Chase); one bailed out (AIG).
  - IMF had suggested reconfiguring CSEs as FHCs in 2007; the CSE program was wound up and CSEs became FHCs or were otherwise absorbed.
- Supervision challenges identified:
  - OTS weaknesses: absence of consolidated capital requirements, small size, reliance on supervisory assessments paid by a few large institutions.
  - SEC weaknesses: mission emphasizing ex post enforcement over ex ante prudential guidance and the nonstatutory nature of the CSE program.
  - Fed umbrella supervision most robust but limited by GLBA “functional deference” and initial reluctance to examine nonbank affiliates.
- Dodd–Frank Act reforms as described:
  - Leaves one consolidated regulator: the Fed to cover holding companies that own FDIC-insured depositories and holding companies that own no depositories but are considered potentially systemic.
  - Holding companies considered potentially systemic, and “large, interconnected BHCs” (with group assets of $50 billion or more), are to be held to higher standards focused on systemic risk.
  - Administration had pushed to close exceptions for limited-purpose banks and unitary grandfathered thrifts; Dodd–Frank imposed a moratorium on new charters for and ownership transfers of limited-purpose banks pending a GAO review and preserved unitary grandfathered thrifts.
  - Unification of consolidated oversight at the Fed is welcomed; remaining exceptions are noted as disappointing.

### Risks in systemic designation and alternative approaches
- Public designation risks cementing market expectations of possible federal support (“halo effect”).
- Leaving large, leveraged, and interconnected conglomerates with no depository subsidiaries unsupervised—or firms divesting depository subsidiaries to escape supervision—was deemed unacceptable.
- Alternatives considered:
  - Casting a wider net to include all holding companies owning FDIC-insured depositories, securities broker-dealers, or futures commission merchants to allow consolidated supervisor to concentrate on systemic groups; risk: bringing many nonsystemic nondepository holding companies under the Fed.
  - Using a size threshold (e.g., group assets of $50 billion or more) to limit nondepository groups swept into the net; risk: creating a halo effect.
- Final legislation: system to designate nondepository holding companies as potentially systemic and bring them under Fed consolidated supervision, subject to an appeals process.

### Recommendations and conclusion (seven goals — “first-best”)
- One, and only one, federal program of consolidated regulation and supervision, grounded in statute and housed at the Fed.
- Cover in this program all holding companies that own one or more FDIC-insured depository institutions, regardless of charter type and without exception, plus any other financial firms deemed jointly by the Fed and FSOC to be potentially systemic.
- Give this program the dual mandate of supporting the safety and soundness of the covered groups individually and mitigating systemic risk they create collectively.
- Impose and require the Fed to enforce strict activity restrictions on groups covered by this program, prohibiting them from engaging in most commercial activities.
- Require the Fed, through this program, to impose and enforce prudential norms at the consolidated level, with a system of mandatory supervisory actions, and to subject the largest and most interconnected of the covered groups to stricter standards.
- Authorize the Fed, through this program, to impose additional requirements on any regulated or unregulated subsidiary, with due attention to regulatory differences by type of firm, softening but not eliminating deference requirements.
- Vest the Fed, through this program, with additional, discretionary enforcement authorities, up to and including orders to divest business lines or subsidiaries.

### Progress made and implementation challenges
- Progress: Having one, and only one, consolidated program enshrined in law and housed at the Fed creates a robust organizational framework for prudential requirements and risk-management controls.
- Implementation challenges:
  - Extending consolidated regulation and supervision to systemic nonbank consortia.
  - Harmonizing prudential rules across banks, broker-dealers, and insurers with different business models and risk profiles.
  - Fed will need to reallocate resources from banking to securities and other nonbanking operations of the groups that it oversees.
  - Consolidated supervision remains one part of the regulatory toolkit; entity-level regulation remains essential.
  - Tail risks remain that potentially systemic players could slip through the consolidated supervisory net (examples cited: a standalone hedge fund, or an AIG Financial Products-type derivative company).

### Key proposals and legislative outcomes (high-level items summarized)
- Depository institution and holding company oversight:
  - Proposals and outcomes address the federal thrift charter, interstate branching, exceptions for unitary grandfathered thrifts and ILCs, and converting SLHCs into BHCs supervised by Fed.
  - Proposals include moratoria on certain ILC approvals and transfers, Fed authority to require SLHCs with significant commercial business to place financial activities in intermediate holding companies supervised by Fed.
  - New activity restrictions (“Volcker Rule”) proposals proscribe proprietary trading and investing in or sponsoring hedge or private equity funds for banks and bank affiliates; variations include permitting Fed to prohibit proprietary trading by potentially systemic financial companies and complex exceptions/transition arrangements.
- Systemic risk mitigation and resolution:
  - Institutional arrangements: create FSOC; FSOC to identify potentially systemic nonbank financial companies and activities; FSOC backed by Office of Financial Research in some proposals.
  - Systemic risk regulation and supervision: require Fed to subject identified systemic nonbank financial companies, and any large interconnected BHCs at its discretion (must include all BHCs with assets ≥ $50 bn in some proposals), to “enhanced supervision and prudential standards.”
  - Break-up powers: authorize Fed to require divestitures by identified systemic nonbank financial companies and large interconnected BHCs (with assets ≥ $50 bn) if they pose “grave threat” to financial stability; authorize FDIC and Fed jointly to require divestitures in event of persistent deficiencies in mandatory resolution plans.
  - Resolution regime: apply special resolution mechanism to any financial company not already under a dedicated carve-out from the Bankruptcy Code, including any BHC or identified systemic nonbank financial company; authorize Treasury Secretary to appoint FDIC as receiver but not conservator for up to 5 years with specified authorities; require rapid and orderly resolution plans from identified firms.
- Resolution funding proposals:
  - Authorize FDIC to borrow from Treasury ≤ $150 bn (or ≤ $200 bn subject to approval by Congress); liquidation costs to be borne by shareholders and unsecured creditors; excess liquidation costs to be covered through ex ante risk-based assessments on financial companies with assets ≥ $50 bn (or hedge funds ≥ $10 bn) until fund balance reaches $150 bn (in some proposals).
  - Alternative proposals authorize FDIC to borrow from Treasury ≤ 10 percent of book value plus 90 percent of fair value of aggregate assets of firms under special receivership; liquidation costs to be borne by shareholders and unsecured creditors; excess liquidation costs to be covered through ex post risk-based assessments on BHCs with assets ≥ $50 bn and identified systemic nonbank financial companies.

### Emergency Financial Stabilization — Fed credit accommodations and FDIC guarantee authority (table summary)
- Fed credit accommodations under Section 13(3) of Federal Reserve Act:
  - Administration: require ex ante written approval by Treasury Secretary; limit to broadly available liquidity programs for individuals, partnerships, or corporations, with ≥ 99 percent probability of repayment, after determination of “liquidity event” by FSOC and consent by Treasury Secretary (in consultation with President); may not exceed $4 trn; may be halted by Congress.
  - House: limit to broadly available liquidity programs for solvent nonbank financial firms, subject to ex ante approval by Treasury Secretary and ex post reporting to Congressional committees and GAO audit; Fed to develop guiding regulations in consultation with Treasury Secretary; no cap; no veto by Congress.
  - Senate / Dodd–Frank Act: limit to broadly available liquidity programs for solvent nonbank financial firms, subject to ex ante approval by Treasury Secretary and ex post reporting to Congressional committees and GAO audit; Fed to develop guiding regulations in consultation with Treasury Secretary; no cap; no veto by Congress.
- FDIC guarantee authority:
  - Administration: authorize assistance to open (including failing) financial institutions, including through loans, asset purchases, guarantees, and equity investments.
  - House: limit to broadly available guarantees on obligations of solvent FDIC-insured depositories and their holding companies, after determination of “liquidity event” by FSOC and consent by Treasury Secretary (in consultation with President); Congress to approve amounts > $500 bn; FDIC to develop guiding regulations in consultation with FSOC and Treasury Secretary; all of above to sunset at end-2013.
  - Senate / Dodd–Frank Act: limit to broadly available guarantees on obligations of solvent FDIC-insured depositories and their holding companies, after joint determination of “liquidity event” by Fed and FDIC upon request by Treasury Secretary; Treasury Secretary to recommend maximum amount to President, Congress to approve; FDIC to develop guiding regulations in consultation with Treasury Secretary; no sunset.

*Source: _wp1123 - Preface (IMF).*

### Preface ................................................................................................................

### _wp1123 - Preface ................................................................................................................

### Preface: context and scope
- Builds on a Technical Note (IMF Country Report No. 10/251) produced as part of the IMF’s 2010 FSAP assessment of the United States.
- FSAP involved two sets of meetings, during October 14–November 3, 2009 and February 17–March 12, 2010.
- Interlocutors included the U.S. Department of the Treasury, Federal Reserve (Fed), Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of the Currency (OCC), Office of Thrift Supervision (OTS), Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC), and Federal Housing Finance Agency.
- Paper reflects discussions and comments from the above bodies; focuses on incumbent regulatory arrangements while acknowledging changes introduced by the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010.
- Emphasizes prerequisites for effective oversight: high-quality information-sharing, coordination, systemic risk analysis, accountability, and clarity of mandates (as highlighted in IMF Country Report Nos. 10/247 and 10/250).

### Executive summary: purpose, view on consolidated supervision, and key recommendation
- Reviews outgoing U.S. consolidated regulatory and supervisory arrangements and retrospects on options to strengthen them.
- Argues group-level regulation and supervision are potent tools of financial sector oversight and key to mitigating systemic risk.
- Notes a very significant share of the U.S. financial system is controlled by a few key holding companies; the “mega-diversified” conglomerates are heterogeneous and systemic, posing a critical supervisory challenge.
- Changes needed (or were): eliminate exceptions for holding companies owning certain limited-purpose banks; harmonize arrangements for bank and thrift holding companies; bring into the net a few systemic nonbank financial groups.
- Fed identified as best placed to bear consolidated supervisory mandate but will need to reallocate resources toward securities and nonbanking operations in large complex conglomerates.

- Box 1 — United States: Key Recommendations on Consolidated Oversight:
  - Organization and location: Establish one, and only one, federal program of consolidated regulation and supervision, grounded in statute and housed at the Fed.
  - Scope: Cover in this program all holding companies that own one or more FDIC-insured depository institutions, regardless of charter type and without exception, plus any other financial firms deemed to be potentially systemic, through selection procedures to be established.
  - Mandate: Give this program the dual mandate of supporting the safety and soundness of the covered groups individually and mitigating any systemic risk they may create collectively.
  - Activity restrictions: Prohibit covered groups from engaging in most commercial activities, and require the Fed to enforce such prohibitions.
  - Prudential norms: Require the Fed, through this program, to impose and enforce prudential requirements at the consolidated level, with a system of mandatory supervisory actions, and to subject the largest and most interconnected of the covered groups to stricter standards.
  - Deference: Authorize the Fed, through this program, to impose additional requirements on any regulated or unregulated subsidiary, with due attention to regulatory differences by type of firm, softening but not eliminating deference requirements vis-à-vis bank and functional regulators.
  - Additional enforcement powers: Vest the Fed, through this program, with additional, discretionary enforcement authorities, up to and including orders to divest business lines or subsidiaries.

### I. Introduction and context — crisis lessons and institutional responses
- Regulatory and supervisory failures and gaps rank high among causes of the global financial crisis of 2007–09.
- Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 enacted as major post-crisis reform; FSAP supportive and advocated for bolder action where warranted.
- Focus of reforms: better mitigation of systemic risk, broadly defined as the risk that actions of one or several financial intermediaries adversely affect others and the economy.
- Congress established the Financial Stability Oversight Council (FSOC) as the “systemic risk regulator,” a council of Treasury, the Fed, and federal financial regulatory agencies to be apex decision-making body on financial stability.
- FSAP team emphasizes a strong role for the Fed as “lead executor” of the FSOC given its monetary policy, lender-of-last-resort duties, and consolidated supervisory authorities over bank holding companies.
- Outgoing system had three federal consolidated supervisors: the Fed, the OTS, and the SEC; paper concurs with Congress that there should be only one consolidated supervisor: the Fed.

### II. Regulation, system structure, and the role of conglomerates
- U.S. financial system shaped by regulatory/tax forces and innovation/arbitrage; key contours from the Great Depression persist (separation of banking from full-scope securities underwriting and commerce; retail deposit-taking institutions as special).
- Federally insured depository institutions are “special” due to public policy privileges: access to Fed standing facilities, settlement through Fedwire Funds Service, discount window borrowing, and FDIC or NCUA deposit insurance.
- Counts and institution types (as of dates in Preface):
  - 6,622 FDIC-insured commercial banks as of end-September 2010.
  - 1,138 FDIC-insured savings institutions as of end-September 2010.
  - 10 FDIC-insured branches of foreign banks in the system as of end-September 2010.
  - 7,445 NCUA-insured credit unions as of end-June.
- Asset-share dynamics:
  - Federally insured depository institutions: share of U.S. financial sector assets fallen from about one-half in 1980 to close to one-fifth currently.
  - Housing GSEs’ share of U.S. financial sector assets doubled from about one-twentieth in 1980 to over one-tenth currently; GSE MBS account for essentially all residential mortgage securitization post-crisis.
  - Shadow banking system’s share increased from about one-tenth in 1980 to about one-quarter currently.
  - ABS pools at pre-crisis peak held over one-fifteenth of U.S. financial sector assets.
- Three broad segments of the system:
  - The government-supported core: federally insured depositories and GSEs; subject to safety-and-soundness regulation, dedicated resolution schemes exempting them from automatic stay, and prompt corrective action requirements.
  - The shadow banking system: mortgage brokers, finance companies, private-label ABS and ABCP issuers, SIVs, money market funds, broker-dealers, derivative product companies, hedge funds, holding companies; wholesale funded and subject to Bankruptcy Code automaticity (except where legal structures alter outcomes).
  - The “real money” periphery: pension funds, mutual funds, commodity pool operators, insurance companies and other collective investment schemes—tend to have little or no leverage and are subject to conduct-of-business rules rather than safety-and-soundness requirements.

- Shadow system specifics and vulnerabilities:
  - Wholesale funding chains rely on repurchase and securities lending with collateral often substituting for counterparty due diligence.
  - Money market mutual funds subject to Rule 2a-7 of the Investment Company Act of 1940 but not daily onsite supervision like big wholesale-funded banks.
  - Securities broker-dealers and futures commission merchants subject to net liquid assets standard requiring liquid assets to exceed all liabilities.
  - Hedge funds largely unregulated; investment advisors often not required to register or report.
  - ABS trusts are special-purpose, with no controlling shareholders, limited decision-making power, opaque portfolios of self-liquidating assets, and liability features (e.g., early amortization) designed to avoid formal events of default under the Bankruptcy Code.

*Source: _wp1123 - Preface (IMF).*

### 12.      The U.S. “regulatory perimeter” may thus be stylized as two concentric circles.

### _wp1123 - 12.      The U.S. “regulatory perimeter” may thus be stylized as two concentric circles.

### Regulatory perimeter: structure and gaps
- Stylized as two concentric circles:
  - Inner ring: depositories and the housing GSEs; subject to intensive, hands-on, safety-and-soundness regulation and supervision, consumer protection, investor protection, and access-to-finance rules.
  - Outer ring: all other types of regulated financial entities (including insurers, real money investors, and many “shadow banks”); regulated for consumer and investor protection but generally not supervised under an explicit safety-and-soundness mandate.
  - Outside the outer ring: certain private pools of capital (e.g., derivative product companies and hedge funds) and instruments (e.g., credit derivatives and “144A” securities marketed only to “qualified institutional buyers,” the latter including many private-label ABSs) left entirely unregulated.

- Financial groups often straddle both perimeters, combining insured depositories, securities broker-dealers, futures commission merchants, insurers, servicers, managed funds, ABS pools, derivative product companies, and other entities under centralized enterprise-wide management.
  - Implicit recourse, operational and reputational risks arise from sponsorship or operation of affiliates (e.g., SIVs, hedge funds) based on brand, cross-selling, and game-theoretical commitments rather than formal ownership.
  - A large share of the U.S. financial system is controlled, in one way or another, by a few key holding companies.

### Systemic risk dynamics and crisis experience
- Systemic risk in the crisis often traced to a few large complex groups; risk can flow from one or several legal entities within the group or from interactions between parts.
- When large complex groups face funding difficulty, they tend to fail as one, at speed, with systemic impact.
- All major U.S. crisis interventions cited included federal support at the ultimate holding company level (examples noted: Bear Stearns, AIG, the Capital Purchase Program, the Temporary Liquidity Guarantee Program).
- Uninsured funding was first underpriced, then flighty, undermining market discipline:
  - Small banks funded predominantly by federally insured deposits were more likely to suffer capital-related regulatory intervention than liquidity failure; deposit insurance worked.
  - Large BHCs with significant short-term uninsured funding, and essentially all of the shadow banking system, proved deeply vulnerable to institutional runs.
  - Runs were a herd response on a backdrop of chronic data gaps—on counterparties and collateral, especially in the derivative and unregistered ABS realms—and followed prolonged periods of poorly managed risk-taking.
- Conclusion: both regulation/supervision and market discipline fell short, underscoring the need for more effective oversight.

### Consolidated regulatory and supervisory arrangements in the United States
- Consolidated supervision mirrors enterprise-wide management, “peering through” corporate separations to focus on group-level interactions and risk management from the holding company level.
- U.S. consolidated oversight programs involve multiple regulators working together, with a consolidated supervisor as the nodal point, vested with powers to inspect any entity within the group.
- U.S. consolidated supervision has been bank-centric:
  - All holding companies that own insured depositories are regulated and supervised in principle.
  - BHCs have been under the Fed since 1956; SLHCs under the OTS (previously the Federal Home Loan Bank Board) since 1967.
  - There were 4,861 BHCs and 436 SLHCs in the system as of end-September 2010.
  - Statutory oversight for BHCs and SLHCs had a single-point mandate: to protect the safety and soundness of federally insured depositories within the group; a “source of strength” doctrine expects holding companies to support insured depository subsidiaries.

- Important statutory gaps and complexities undermined effectiveness:
  - Exceptions to BHC status: certain thrifts and limited-purpose banks (ILCs, credit card banks, trust companies, “nonbank banks”) are not deemed banks for the Bank Holding Company Act of 1956; companies that own them are not BHCs and are exempt from Fed oversight. Former “big five” investment banking groups used this exemption.
  - Exceptions to SLHC activity restrictions: grandfathered companies owning a single insured thrift since before the Gramm–Leach–Bliley Act of 1999 are exempt from SLHC activity restrictions (but not OTS oversight). Several former “big five” groups and large nonfinancial firms (e.g., GE and John Deere) used this exemption. SLHCs have not been subject to any consolidated capital floor.
  - Financial holding company (FHC) construct (GLBA): expanded permissible activities to “financial in nature or incidental to such” or “complementary to a financial activity.” Only BHCs with depository subsidiaries classified as “well-capitalized” and “well-managed” could elect FHC status, with the Fed as “umbrella supervisor” directed to defer “to the fullest extent possible” to functional regulators. There were 512 FHCs in the system as of end-September 2010.

### Consolidated supervision of investment banks: SIBHC and CSE programs
- Broker-dealer supervision focuses on customer protection rather than safety-and-soundness: Rule 15c3-1 (the “net capital rule”) aims to protect customers and enable orderly liquidation without formal proceedings or SIPC assistance.
- Two elective consolidated protocols:
  - SIBHC program: GLBA-created broker-dealer holding company with SEC as consolidated supervisor; SEC directed to defer “to the fullest extent possible” to functional regulators and to limit examinations to risks that could have a “materially adverse effect” on securities broker-dealers. Only one SIBHC existed (Lazard).
  - CSE program: nonstatutory SEC regime created in response to Directive 2002/87/EC; added appendices to Rule 15c3-1 including a value at risk-based “alternative net capital rule” with a Basel capital computation and holding company prudential requirements (including two liquidity standards). All of the “big five” U.S. investment banking groups became CSEs.

- Features and frictions of these arrangements:
  - Neither SIBHC nor CSE imposed activity restrictions.
  - CSE program imposed absolute capital norms for participating holding companies: required at least one securities broker-dealer with net capital and “tentative net capital” of not less than $500 million and $1 billion, respectively, and introduced a $5 billion early warning requirement for tentative net capital.
  - The alternative net capital rule provided relief and became the binding floor for eligible broker-dealers; some broker-dealers owned by FHCs opted in.
  - CSE recognized Fed consolidated supervision equivalency for FHCs and exempted FHCs from SEC consolidated oversight, but did not extend equivalency with SLHC supervision—three of the “big five” were supervised by both the SEC and the OTS with minimal coordination.

### Outcomes, reform proposals, and risks
- SLHC and CSE programs were weak points during the crisis:
  - Outcomes among CSEs and SLHCs included: two CSEs acquired by FHCs (Bear Stearns by JPMorgan Chase and Merrill Lynch by Bank of America); two CSEs converted limited-purpose bank subsidiaries into “regular” commercial banks and became FHCs (Goldman Sachs and Morgan Stanley); one collapsed (Lehman Brothers).
  - Among major SLHCs: one taken over by an FHC (Countrywide by Bank of America); one resolved at no cost to the Deposit Insurance Fund (Washington Mutual, bought by JPMorgan Chase); one bailed out (AIG).
  - IMF had suggested reconfiguring CSEs as FHCs in 2007; the CSE program was wound up and CSEs became FHCs or were otherwise absorbed.

- Supervision challenges:
  - OTS weaknesses: absence of consolidated capital requirements, small size, reliance on supervisory assessments paid by a few large institutions; though OTS had reserves to support operations for several years.
  - SEC weaknesses: mission emphasizing ex post enforcement over ex ante prudential guidance and the nonstatutory nature of the CSE program limited binding enforcement at the holding company level.
  - Fed umbrella supervision was the most robust but fell short in examination of nonbank affiliates due to GLBA “functional deference” clauses and concern over creating a “halo effect.” During the crisis the Fed began to directly examine primary dealers.

- Dodd–Frank Act reforms:
  - Leaves one consolidated regulator: the Fed to cover holding companies that own FDIC-insured depositories and holding companies that own no depositories but are considered potentially systemic.
  - Holding companies considered potentially systemic, and “large, interconnected BHCs” (with group assets of $50 billion or more), are to be held to higher standards focused on systemic risk.
  - Administration had pushed to close exceptions for limited-purpose banks and unitary grandfathered thrifts; Dodd–Frank imposed a moratorium on new charters for and ownership transfers of limited-purpose banks pending a GAO review and preserved unitary grandfathered thrifts.
  - Unification of consolidated oversight at the Fed is welcomed; remaining exceptions are noted as disappointing.

- Risks in identifying firms as systemic:
  - Public designation risks cementing market expectations of possible federal support (“halo effect”).
  - Leaving large, leveraged, and interconnected conglomerates with no depository subsidiaries unsupervised—or firms divesting depository subsidiaries to escape supervision—was deemed unacceptable.
  - Alternatives considered:
    - Casting a wider net to include all holding companies owning FDIC-insured depositories, securities broker-dealers, or futures commission merchants to allow consolidated supervisor to concentrate on systemic groups; risk: bringing many nonsystemic nondepository holding companies under the Fed.
    - Using a size threshold (e.g., group assets of $50 billion or more) to limit nondepository groups swept into the net; risk: creating a halo effect.
  - Final legislation: system to designate nondepository holding companies as potentially systemic and bring them under Fed consolidated supervision, subject to an appeals process.

### Recommendations and conclusion
- First-best recommendation comprises seven goals for U.S. consolidated regulation and supervision:
  - To have one, and only one, federal program of consolidated regulation and supervision, grounded in statute and housed at the Fed.
  - To cover in this program all holding companies that own one or more FDIC-insured depository institutions, regardless of charter type and without exception, plus any other financial firms deemed jointly by the Fed and FSOC to be potentially systemic.
  - To give this program the dual mandate of supporting the safety and soundness of the covered groups individually and mitigating systemic risk they create collectively.
  - To impose and require the Fed to enforce strict activity restrictions on groups covered by this program, prohibiting them from engaging in most commercial activities.
  - To require the Fed, through this program, to impose and enforce prudential norms at the consolidated level, with a system of mandatory supervisory actions, and to subject the largest and most interconnected of the covered groups to stricter standards.
  - To authorize the Fed, through this program, to impose additional requirements on any regulated or unregulated subsidiary, with due attention to regulatory differences by type of firm, softening but not eliminating deference requirements.
  - To vest the Fed, through this program, with additional, discretionary enforcement authorities, up to and including orders to divest business lines or subsidiaries.

*Source: _wp1123 - 12.      The U.S. “regulatory perimeter” may thus be stylized as two concentric circles.*

### 27.      Even with several—but by no means all—of these objectives met, financial sector

### Even with several—but by no means all—of these objectives met, financial sector oversight in the United States has taken a significant step forward

### Progress in consolidated regulation and supervision
- Having one, and only one, program of consolidated regulation and supervision, enshrined in law and housed at the Fed, creates a robust organizational framework around which to build a new generation of prudential requirements and risk-management controls.
- Financial conglomerates, especially those that are large and complex, are managed at the enterprise level; U.S. regulatory and supervisory arrangements are continuing to adapt to reflect this.

### Implementation challenges ahead
- Extending consolidated regulation and supervision to systemic nonbank consortia is a key challenge.
- Effective group-level regulation must “prescribe and proscribe what must be done and what may not be done in specific areas” and set parameters for leverage and liquidity; melding rules conceived for banks with those for broker-dealers or insurers with very different business models and risk profiles will not be easy.
- On the supervisory side, the Fed will need to reallocate resources from the banking to the securities and other nonbanking operations of the groups that it oversees.
- Consolidated supervision will remain only one part of the regulatory armory; entity-level regulation will remain the “coal face,” where sectoral regulatory expertise meets industry reality.
- Tail risks remain that potentially systemic players could slip through the consolidated supervisory net (example types cited: a standalone hedge fund, or an AIG Financial Products-type derivative company).
- The regulatory system will continue to require both robust consolidated supervision and careful, case-by-case consideration of appropriate regulatory treatment of all financial intermediaries by legal form, currently most relevant to certain “bank-like” entities in the shadow system.

### Key proposals and legislative outcomes (Appendix Table 1 highlights; As of July 21, 2010)
- Depository institution and holding company oversight:
  - Proposals and outcomes address the federal thrift charter (retain, eliminate, or transition), interstate branching, exceptions for unitary grandfathered thrifts and ILCs, and converting SLHCs into BHCs supervised by Fed.
  - Proposals include imposing a 3-year moratorium on approval of applications for FDIC deposit insurance by ILCs and other limited-purpose banks owned by commercial firms and on transfers of control that would result in commercial firm control; require study of issue by GAO; preserve unitary grandfathered thrift exception; Fed may require SLHCs with significant commercial business to place all financial activities in intermediate holding companies supervised by Fed.
  - New activity restrictions (“Volcker Rule”) proposals: proscribe banks and bank affiliates from proprietary trading and investing in or sponsoring hedge or private equity funds; variations include permitting Fed to prohibit proprietary trading by potentially systemic financial companies and complex exceptions/transition arrangements.

- Systemic risk mitigation:
  - Institutional arrangements: create FSOC; FSOC to identify potentially systemic nonbank financial companies and activities; FSOC backed by Office of Financial Research in some proposals; FSOC and Fed authorized to request and receive information for financial stability purposes from other regulators or any financial firm.
  - Systemic risk regulation and supervision: require Fed to subject identified systemic nonbank financial companies, and any large interconnected BHCs at its discretion (must include all BHCs with assets ≥ $50 bn in some proposals), to “enhanced supervision and prudential standards”; Fed may require potentially systemic nonbank financial companies with significant commercial business to place all financial activities in intermediate holding companies.
  - Break-up powers: authorize Fed to require divestitures by identified systemic nonbank financial companies and large interconnected BHCs (with assets ≥ $50 bn) if “at later stages of financial decline” or if it determines, and FSOC concurs, they pose “grave threat” to financial stability; authorize FDIC and Fed jointly to require divestitures in event of persistent deficiencies in mandatory resolution plans.

- Payment, clearing, and settlement system oversight:
  - Subject FSOC-identified systemic utilities to heightened and uniform risk management standards and (primary or back-up) supervision by Fed; those not chartered as banks may be granted access to Fedwire and, in extremis, to the discount window.

- Resolution regime:
  - Coverage: apply special resolution mechanism to any financial company not already under a dedicated carve-out from the Bankruptcy Code, including any BHC or identified systemic nonbank financial company, whose failure would be systemically destabilizing; invoke using procedures modeled on systemic risk exception; in some proposals subject to approval of U.S. District Court for the District of Columbia.
  - Resolution agency, objectives, and tools: authorize Treasury Secretary to appoint FDIC as receiver but not conservator for up to 5 years with authority to replace management, transfer QFCs, repudiate contracts, provide up-front financial assistance, and establish bridge financial company for up to 5 years.
  - Resolution funding:
    - Authorize FDIC to borrow from Treasury ≤ $150 bn (or ≤ $200 bn subject to approval by Congress); liquidation costs to be borne by shareholders and unsecured creditors; excess liquidation costs to be covered through ex ante risk-based assessments on financial companies with assets ≥ $50 bn (or hedge funds ≥ $10 bn) until fund balance reaches $150 bn (in some proposals).
    - Alternative proposals authorize FDIC to borrow from Treasury ≤ 10 percent of book value plus 90 percent of fair value of aggregate assets of firms under special receivership; liquidation costs to be borne by shareholders and unsecured creditors; excess liquidation costs to be covered through ex post risk-based assessments on BHCs with assets ≥ $50 bn and identified systemic nonbank financial companies.
  - Resolution plans: require identified systemic nonbank financial companies and large interconnected BHCs (with assets ≥ $50 bn) to periodically submit rapid and orderly resolution plans to FDIC, Fed, and FSOC.

*Appendix Table 1. United States: Key Financial Stability Proposals and Outcomes (As of July 21, 2010).*

### Appendix Table 1 (concluded). United States:

### Appendix Table 1 (concluded). United States: Key Financial Stability Proposals and Outcomes (As of July 21, 2010)

### Emergency Financial Stabilization — Fed credit accommodations under Section 13(3) of Federal Reserve Act
- Administration
  - Require ex ante written approval by Treasury Secretary
  - Limit to broadly available liquidity programs for individuals, partnerships, or corporations, with ≥ 99 percent probability of repayment, after determination of “liquidity event” by FSOC and consent by Treasury Secretary (in consultation with President); may not exceed $4 trn; may be halted by Congress
- House
  - Limit to broadly available liquidity programs for solvent nonbank financial firms, subject to ex ante approval by Treasury Secretary and ex post reporting to Congressional committees and GAO audit; Fed to develop guiding regulations in consultation with Treasury Secretary; no cap; no veto by Congress
- Senate / Dodd–Frank Act
  - Limit to broadly available liquidity programs for solvent nonbank financial firms, subject to ex ante approval by Treasury Secretary and ex post reporting to Congressional committees and GAO audit; Fed to develop guiding regulations in consultation with Treasury Secretary; no cap; no veto by Congress

### Emergency Financial Stabilization — FDIC guarantee authority
- Administration
  - Authorize assistance to open (including failing) financial institutions, including through loans, asset purchases, guarantees, and equity investments
- House
  - Limit to broadly available guarantees on obligations of solvent FDIC-insured depositories and their holding companies, after determination of “liquidity event” by FSOC and consent by Treasury Secretary (in consultation with President); Congress to approve amounts > $500 bn; FDIC to develop guiding regulations in consultation with FSOC and Treasury Secretary; all of above to sunset at end-2013
- Senate / Dodd–Frank Act
  - Limit to broadly available guarantees on obligations of solvent FDIC-insured depositories and their holding companies, after joint determination of “liquidity event” by Fed and FDIC upon request by Treasury Secretary; Treasury Secretary to recommend maximum amount to President, Congress to approve; FDIC to develop guiding regulations in consultation with Treasury Secretary; no sunset
- Senate (duplicate entry in table)
  - Limit to broadly available guarantees on obligations of solvent FDIC-insured depositories and their holding companies, after joint determination of “liquidity event” by Fed and FDIC upon request byTreasury Secretary; Treasury Secretary to recommend maximum amount to President, Congress to approve; FDIC to develop guiding regulations in consultation with Treasury Secretary; no sunset

*Sources: Administration proposals; House-passed bill; Senate-passed substitute; Final House- and Senate-passed bill.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2011/_wp1123.pdf_