Systematically Important Financial Institution - Explained
What is a Systematically Important Financial Institution?
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Table of ContentsWhat is a Systemically Important Financial Institution?How Does a Systemically Important Financial Institution Work?Criticisms of SIFIs
What is a Systemically Important Financial Institution?
A Systemically Important Financial Institution (SIFI) is a financial institution in the United States that is perceived to pose a serious risk to the economy if it fails. This could be a bank, an investment bank, a brokerage firm or an insurance company. SIFI is a term used to describe financial institutions that are too big to fail, given their importance to the U.S economy. SIFI institutions are subjected to additional regulations that normal financial institutions because their failure might lead to a financial crisis in the entire economy. The U.S Federal Reserve and other regulators subject SIFIs to extra scrutiny. SIFI framework is also developed to avert the potential failure of such institutions.
How Does a Systemically Important Financial Institution Work?
The Financial Stability Oversight Council (FSOC) is a regulatory in the U.S with the oversight function of labeling financial institutions as SIFIs if they meet certain criteria. As established by the Dodd-Frank Act of 2010, FSOC is responsible for developing a framework that would tackle the systemic risks that could lead to the failure of SIFIs. Any bank, investment bank or insurance company that is labeled as a SIFI automatically attracts strict regulations and oversight by the Federal Reserve. The increased scrutiny of SIFIs borders on;
- Huge capital requirements,
- Stringent regulations,
- Periodic stress tests, and
- The development of living wills.
The Dodd-Frank Act was enacted as a response to the 2008 financial crisis which led to the collapse of large institutions and industries in the U.S. This Act created the FSOC to act as a mediator between the economy and SIFIs. Generally, the FSOC examine financial institutions and label them according to the level of risks they pose to the U.S economy. Systemically Important Financial Institutions (SIFIs) pose a significant amount of risks to an economy in the event of their failure or collapse. Some of the financial institutions labeled as SIFIs by the FSOC between 2013 and 2014 are; American International Group Inc. (AIG), General Electric Capital Corp Inc. (GE), MetLife Inc. (MET), and Prudential Financial Inc. (PRU).
Criticisms of SIFIs
The following are some criticisms against the systemically important financial institution (SIFI);
- Critics argue that SIFIs only label financial institutions as too big to fail, but does not prevent them from failing.
- Although institutions with the SIFI label are exposed to higher scrutiny and regulations, these do not necessarily safeguard them from failing or collapsing.
- Increased regulations of SIFIs create additional burdens for them that sometimes expose them to bigger risks.