WASHINGTON—A three-stage, detailed process will be used to determine whether a non-bank such as an insurer will be designated as systemically significant under a regulation proposed by the Financial Stability Oversight Council today.

The process will include the opportunity for the proposed institution to request a public hearing, FSOC officials said.

The proposal, approved for public comment by the FSOC, was described as “proposed interpretive guidance,” by Lance Auer, a staff official at the Federal Deposit Insurance Corporation who helped draft the proposal.

The new proposal will have a 60-day public comment period, with FSOC action on the final rule expected later this year, the Treasury Department said in issuing the rule. The process, if approved, will be as follows:

  • Application of a uniform quantitative threshold for identifying a subset of a non-bank financial company (NFC) that warrants further review
  • Assessment of the subset of NFCs identified in stage 1, based on available public and regulatory information
  • Contact to individual NFCs that warrant further review

According to Auer, only after an NFC clears these 3 stages of review can the FSOC make a SIFI determination under Section 113. 

Further, the FSOC must issue its findings in writing, and then apply the “due process” procedures outlined for designated SIFIs under the Dodd-Frank Act. 

The guidance that will be used in designating a non-bank as systemically significant is being re-proposed after the FSOC came under intense pressure from insurers and their supporters in Congress to be more specific in disclosing the qualitative and quantitative standards that will be used in determining whether an institution is systemically important enough to merit additional federal regulation.

In the original proposal, a SIFI designation would be based on such general standards as size, leverage, liquidity, lack of substitute products, existing regulatory scrutiny and the degree of inter-connectedness with other financial institutions.

Under the DFA, if an insurer were designated as SIFI, it would be regulated by the Federal Reserve Board as well as state regulators.

It would have to register with the Fed within six months of being so designated, and would be subject to additional capital standards as well as other requirements.

In a note issued today, Fitch Ratings said the clarification of the SIFI criteria would potential be “significant” in differentiating the credit profiles of certain large insurers, particularly with respect to capital requirements and higher operating costs linked to tougher regulatory compliance requirements.

“While stronger capital ratios would in and of themselves represent a credit positive, they could also impose higher costs associated with carrying statutory capital,” Fitch Ratings said.

The potential need to carry higher capital against the same risk exposures could make an insurance company designated a SIFI less competitive than its non-SIFI peers, the statement said.

Currently, most large U.S. insurance organizations hold significant excess capital relative to statutory minimums, the Fitch statement said. “Therefore, the implementation of higher capitals standards may not be a major disadvantage from a practical perspective in the near term,” the report said.

Besides insurance companies, non-banks being considered for such a designation, according to former FDIC chairman Sheila Bair, include hedge funds, private equity firms, specialty lenders and broker-dealers.

In proposing the regulation, Treasury Secretary Timothy Geithner said subjecting financial firms outside “the formal banking system” should help ease “tension and trauma” created by the failure of Lehman Bros., and the near-failure of American International Group, an insurance holding company which was found in September 2008 to have issued $2.77 trillion in credit default swaps as insurance against losses on mortgage-backed securities.

The government, by its own account, at one provided AIG up to $120 billion in borrowing authority to save it from insolvency, as well as guarantees on its commercial paper and other borrowings.

But insurers have argued that AIG is unique and that their business model should not subject them to federal oversight in addition to its current state regulation.

In a comment letter urging caution in designating insurers as SIFI, for example, the American Insurance Association asked the FSOC to consider its industry “unique and fundamentally different than banking and other financial services.”