What Is a Systemically Important Financial Institution (SIFI)?
A systemically important financial institution (SIFI) is a bank, insurance, or other financial institution that U.S. federal regulators determine would pose a serious risk to the economy if it were to collapse. A SIFI is viewed as “too big to fail” and imposed with extra regulatory burdens to prevent them from going under. However, a SIFI label brings more scrutiny and extra regulations.
- A systemically important financial institution (SIFI) is a firm that U.S. regulators determine would pose a serious risk to the economy if it were to collapse.
- This label imposes extra regulatory requirements and increased scrutiny, including strict oversight by the Federal Reserve, higher capital requirements, periodic stress tests, and the need to produce "living wills."
- Last year, President Donald Trump signed a bill to pare back parts of the Dodd-Frank Act, raising the threshold that determines which companies qualify as a systemically important financial institution (SIFI).
- The changes should see many mid-sized FIs save millions in regulatory compliance costs and give them greater flexibility to expand their businesses.
Understanding Systemically Important Financial Institution (SIFI)
The Great Recession was mainly blamed on financial firms taking on too much risk. Regulators recognized that closer scrutiny in the future would be paramount to prevent a repeat, noting that many companies in this industry are deeply ingrained in the functionality of the economy. Or, as they put it: too big, complex, and interconnected to fail.
The 2010 Dodd-Frank Act, a response to the financial crisis, established the Financial Stability Oversight Council (FSOC), giving it the authority to label banks and other firms systemically important financial institutions (SIFIs).
This label imposes extra regulatory requirements and increased scrutiny. These include strict oversight by the Federal Reserve, higher capital requirements, periodic stress tests, and the need to produce "living wills"—plans to wind up operations without triggering a financial crisis or requiring a bailout.
Financial institutions (FIs) displaying signs of stress under testing are required to postpone share repurchases, curtail dividend plans and, if necessary, raise additional capital.
The law is designed to prevent a repeat of the 2008 financial crisis, which saw largely unregulated institutions such as American International Group Inc. (AIG) require large taxpayer-funded bailouts. Reasoning that financial contagion could originate in unexpected places, legislators created the FSOC to examine firms according to the risk posed by their size, financial position, business models, and interconnectedness to other areas of the economy.
Qualifications for Systemically Important Financial Institution (SIFI)
The process for determining which companies are systemically important financial institutions (SIFIs) has undergone some changes of late. Previously, FIs with more than $50 billion in assets were labeled as systemically important.
Then, in 2018, following a wave of complaints from smaller banks struggling to handle the costs of complying with enhanced regulation, President Donald Trump, who described the Dodd-Frank Act as “a very negative force,” signed into law a partial rollback. The bill increased the systemically important financial institution (SIFI) threshold to $100 billion and then all the way up to $250 billion 18 months later.
The changes are expected to liberate roughly 26 banks from rigorous annual stress tests, bringing the number of institutions facing heightened scrutiny down to about 12. Those freed look set to save millions in regulatory compliance costs. Less oversight should also give them greater flexibility to expand their businesses.
Factors of Systemically Important Financial Institution (SIFI)
In the past, the process of determining whether a non-bank institution poses systemic risks has come under heavy criticism. MetLife Inc. (MET) won a lawsuit protesting its systemically important status in March 2016, with the judge calling the government's decision to label the life insurer as such "arbitrary and capricious.”
Skeptics of the systemically important financial institution (SIFI) label and of Dodd-Frank's regulations more generally have argued that rather than preventing firms from being "too big to fail," the designation merely identifies the ones that are.
Some argue that the increased regulatory burden has, in fact, exacerbated the risk of financial contagion: since larger banks are better able to shoulder the extra costs, they come out stronger—and bigger—as a result, ironically giving rise to greater concentration in the financial sector.
President Trump's 2018 CRAPO bill, otherwise known as the Economic Growth, Regulatory Relief, and Consumer Protection Act, was intended to eliminate this threat by freeing mid-sized lenders from strict and costly regulatory scrutiny.