The Director of the Consumer Financial Protection Bureau (CFPB), Rohit Chopra, made a statement on Friday emphasizing the need for greater market discipline in the shadow banking sector. He highlighted the role of the Financial Stability Oversight Council (FSOC) in eliminating the expectation of government protection from losses in the event of company failure.
Chopra pointed out that financial history often repeats itself, with regulators and policymakers forgetting the lessons learned from periods of instability. However, he noted that families across the country do not have this luxury, as the economic and psychological damage inflicted by a crisis can linger for many years.
Congress created the FSOC to promote market discipline and prevent shareholders, creditors, and counterparties from expecting government protection from losses. More specifically, under Section 113 of the Dodd-Frank Act, the FSOC has the responsibility of designating systemically important nonbank financial institutions that could pose a threat to financial stability.
A designated firm may be required to invest more capital to absorb losses, maintain more cash to mitigate the likelihood and impact of runs, and file “living wills” to demonstrate the firm’s ability to fail without needing a bailout.
Despite the vast universe of asset managers, hedge funds, private equity firms, nonbank mortgage companies, and insurers, the FSOC currently has not designated any shadow banks as systemically important. This absence of designation has led many market participants to perceive the statutory authority to designate as dead letter.
Chopra expressed strong support for the recent move towards promoting market discipline. He noted that the removal of procedural restrictions established in 2019 sets up a more suitable and enduring process for using the designation authority.
He also urged for the implementation of guidance to evaluate whether any shadow bank meets the statutory threshold for enhanced oversight. He stated that he doubts the answer to this is zero and suggested that this effort should build on the work that FSOC Committees, such as the Hedge Fund Working Group and Nonbank Mortgage Task Force, have already conducted in the context of sector-wide reviews.
Chopra concluded his statement by reminding everyone of the lessons learned from the 2008 financial crisis. He stressed that unchecked shadow banking risks can devastate households and small businesses across the country. He also warned that a lax approach to these risks could disadvantage smaller players and regulated institutions.
Chopra’s statement underscores the need for stricter oversight and regulation of the shadow banking sector. As the CFPB continues its work, it is clear that ensuring financial stability and protecting consumers from potential financial crises will remain at the forefront of its priorities.
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