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August 9, 2010 Monday 10:33 AM EST
A.M. Best Special Report: Financial Reform Legislation Leaves Much Unresolved on Systemic Risk
The newly enacted Dodd-Frank Wall Street Reform and Consumer Protection Act leaves many details for regulators to interpret and implement, with significant ambiguities and daunting issues to be sorted out via the rule making process. Of particular importance is the functioning of the Financial Stability Oversight Council, to be created to address systemic risk. While it remedies various problems of the previous regulatory environment, questions remain as to whether it will be able to proactively address future systemic risk. — Absent a sense of direction for the council, issues are bound to arise from the vast and complex nature of the risk targets; historical differences in mandates and agenda among members; and the current lack of uniform quality and standards in reporting data from different financial sectors.— There is a strong need for consensus within the council on issues such as the nature of systemic risk itself; ideology and strategy in controlling systemic institutions and market utilities; and the extent of regulatory interference with market forces given the global competitive environment.— Most important, any attempt to pre-empt systemic risk has to consider yet unforeseen hiding places for the underlying causes of financial crisesspeculative behaviors that can create market bubbles if ignored.— The financial crisis revealed new dynamics by which risk spread among markets and industries at unforeseen speeds and depths, following channels of globalization, advanced trading technologies, new products and processes, and new correlations among markets.— The new regulatory environment will widen scrutiny of leverage among financial institutions, but challenges abound in capturing sufficient data from unregulated entities, and in coping with the varied scope of data on financial institutions under different regulatory agencies.— Cohesion if not consensus on some fronts is vital to the council’s effective functioning, but targeting systemic risk’s causes will be challenging, given the array of policy viewpoints among the council’s diverse membership.— Questions abound as to the potential cost of regulating systemic risk for U.S. financial institutions; in particular, if other major countries do not follow the U.S. in controlling systemically important institutions and market utilities, the end result would be uneven regulation among different national systems.To download a PDF copy of all A.M. Best Co. banking special reports at no cost and to access data, analytical methodologies and news on the U.S. banking industry, please visit http://www.ambest.com/banks.
August 10, 2010