# Regulatory Reform 10 Years After the Financial Crisis: Systemic Risk Regulation of Non-Bank Financial Institutions

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/crs%3AR45162

## Record

- **Collection:** Congressional research report
- **Document type:** CRS Report
- **Published:** April 12, 2018
- **Citation:** R45162

## Text

Regulatory Reform 10 Years After the
Financial Crisis: Systemic Risk Regulation
of Non-Bank Financial Institutions
-name redactedLegislative Attorney
Updated April 12, 2018

Congressional Research Service
7-....
www.crs.gov
R45162

Systemic Risk Regulation of Non-Bank Financial Institutions

Summary
When large, interconnected financial institutions become distressed, policymakers have
historically faced a choice between (1) a taxpayer-funded bailout, and (2) the destabilization of
the financial system—a dilemma that commentators have labeled the “too-big-to-fail” (TBTF)
problem. The 2007-2009 financial crisis highlighted the significance of the TBTF problem.
During the crisis, a number of large financial institutions experienced severe distress, and the
federal government committed hundreds of billions of dollars in an effort to rescue the financial
system. According to some commentators, the crisis underscored the inadequacy of existing
prudential regulation of large financial institutions, and of the bankruptcy system for resolving the
failure of such institutions.
In response to the crisis, Congress passed and President Obama signed the Dodd-Frank Wall
Street Reform and Consumer Protection Act (Dodd-Frank) in 2010. Titles I and II of Dodd-Frank
are specifically directed at minimizing the systemic risk created by TBTF financial institutions. In
order to minimize the risks that large financial institutions will fail, Title I of Dodd-Frank
establishes an enhanced prudential regulatory regime for certain large bank holding companies
and non-bank financial companies. In order to “resolve” (i.e., reorganize or liquidate)
systemically important financial institutions, Title II establishes a new resolution regime available
for such institutions outside of the Bankruptcy Code.
The Title I regime applies to (1) all bank holding companies with total consolidated assets of $50
billion or more, and (2) any non-bank financial companies that the Financial Stability Oversight
Council (FSOC) designates as systemically important. To date, FSOC has designated four nonbank financial companies for enhanced supervision: AIG, GE Capital, Prudential, and MetLife.
However, FSOC has rescinded its designations of AIG and GE Capital as a result of changes to
those companies, and MetLife successfully challenged its designation in federal court, leaving
Prudential as the sole remaining designee as of the publication of this report.
Legislation that would repeal FSOC’s authority to designate non-banks for enhanced supervision
has passed the House of Representatives (H.R. 10), and a bill that would alter FSOC’s
designation process and standards in more limited ways has also been introduced in the House
(H.R. 4061).
Title II of Dodd-Frank creates an “Orderly Liquidation Authority” (OLA) pursuant to which the
Federal Deposit Insurance Corporation (FDIC) can serve as the receiver for failing financial
companies that pose a significant risk to the financial stability of the United States. The OLA,
which was developed as an alternative to the Bankruptcy Code, is similar to the mechanisms the
FDIC uses to resolve failed commercial banks. The OLA grants the FDIC broad powers to
manage the liquidation or sale of a failed financial company, and Title II includes provisions that
offer financial institutions more robust protections against “runs” by their derivatives
counterparties than they would have under the Bankruptcy Code. The FDIC, Federal Reserve, and
Office of the Comptroller of the Currency have promulgated a number of rules that have
important consequences for the OLA concerning the FDIC’s powers as receiver, its general
strategy for resolving failed institutions, “loss-absorbing capacity” requirements for certain bank
holding companies, and derivatives contracts.
There have also been a number of proposals to reform Title II. A bill that would (among other
things) repeal Title II passed the House in June 2017, and bills to amend the Bankruptcy Code to
allow it to deal more effectively with the failure of large financial institutions have been
introduced in the House and the Senate (H.R. 10 (115th Cong.), H.R. 1667 (115th Cong.), S. 1840
(114th Cong.)).

Congressional Research Service

Systemic Risk Regulation of Non-Bank Financial Institutions

Contents
The “Too-Big-To-Fail” Problem ..................................................................................................... 2
TBTF Financial Institutions During the 2007-2009 Financial Crisis .............................................. 4
Title I: Enhanced Prudential Standards for Systemically Important Financial Institutions............. 9
Designation of Non-Banks for Enhanced Prudential Regulation .............................................11
Dodd-Frank Section 113 and FSOC Guidance ..................................................................11
Non-Bank Designations to Date ....................................................................................... 14
Criticisms of Title I and Responses ......................................................................................... 19
Proposals to Alter Title I ......................................................................................................... 20
Proposed Legislation ......................................................................................................... 20
The Trump Administration’s Views .................................................................................. 20
Title II: Orderly Liquidation Authority.......................................................................................... 21
Pre-Dodd-Frank Resolution Mechanisms: Bankruptcy vs. FDIC Resolution......................... 22
Dodd-Frank and the Orderly Liquidation Authority ............................................................... 28
Legislative History ............................................................................................................ 28
Title II and the Orderly Liquidation Authority ................................................................. 30
Administrative Rules ............................................................................................................... 37
Criticisms of Title II and Responses ....................................................................................... 43
Proposals to Alter Title II ........................................................................................................ 45
Proposed Legislation ......................................................................................................... 45
The Trump Administration’s Views .................................................................................. 47

Tables
Table 1. Differences Between Bankruptcy and FDIC Resolution ................................................. 26
Table 2. QFCs Under the Bankruptcy Code, Federal Deposit Insurance Act, and Title II ............ 42

Appendixes
Appendix. Glossary ....................................................................................................................... 49

Contacts
Author Contact Information .......................................................................................................... 50

Congressional Research Service

Systemic Risk Regulation of Non-Bank Financial Institutions

T

he prospect of a large financial institution’s failure often presents policymakers with a
stark choice. Regulators can “bailout” a distressed institution, risking taxpayer money
and arguably creating incentives for management, shareholders, and creditors of similar
institutions to take excessive risks. Alternatively, the government can allow the
institution to fail, running the risk of financial destabilization.1 Before the 2007-2009
financial crisis, regulators relied on a variety of prudential regulations, federal deposit insurance,
and the Federal Reserve’s emergency lending power to limit the risk of commercial bank
failures.2 Commercial banks are also subject to a special insolvency regime administered by the
Federal Deposit Insurance Corporation (FDIC), in which the FDIC has robust authorities to
rapidly resolve failed banks outside of the Bankruptcy Code.3
However, many non-bank financial institutions fall outside the ambit of these regulations despite
facing risks similar to those confronting commercial banks. Many commentators viewed the
distress and failure of a number of these institutions during the 2007-2009 crisis as highlighting
the inadequacy of existing prudential regulations for such firms, and of the Bankruptcy Code for
resolving their failure.4 The Dodd-Frank Wall Street Reform and Consumer Protection Act of
2010 (Dodd-Frank) adopted two general solutions to these perceived problems.5 First, Title I of
the Act created the Financial Stability Oversight Council (FSOC) and granted it the authority to
designate systemically important non-bank financial companies for enhanced prudential
regulation by the Federal Reserve.6 Second, Title II of Dodd-Frank established the Orderly
Liquidation Authority (OLA), a special resolution regime outside of the Bankruptcy Code that
can be invoked for systemically important financial institutions.7
As discussed in more detail below, federal regulatory agencies have pursued a number of
measures to implement Titles I and II of Dodd-Frank.8 And 10 years after the crisis, legal
commentators continue to debate whether these provisions have improved the resiliency of the
financial system.9 This report provides an overview of how regulatory agencies have
implemented Dodd-Frank’s systemic risk provisions concerning non-bank financial institutions,
and the legal debates surrounding proposals to repeal or change those provisions. In order to
provide necessary background, the first two sections of the report discuss the nature of the “toobig-to-fail” problem and the 2007-2009 financial crisis.10 The report then provides an overview of
Titles I and II,11 their implementation by the relevant federal agencies,12 criticisms of those
1 See “The “Too-Big-To-Fail” Problem” infra.
2 See “Title I: Enhanced Prudential Standards for Systemically Important Financial Institutions” infra.
3 See “Pre-Dodd-Frank Resolution Mechanisms: Bankruptcy vs. FDIC Resolution” infra.
4 See Ben S. Bernanke, Why Dodd-Frank’s Orderly Liquidation Authority Should be Preserved, THE BROOKINGS INST.

(Feb. 28, 2017), https://www.brookings.edu/blog/ben-bernanke/2017/02/28/why-dodd-franks-orderly-liquidationauthority-should-be-preserved/; FINANCIAL REGULATORY REFORM: A NEW FOUNDATION, U.S. DEP’T OF THE TREASURY
20 (Oct. 8, 2009), https://www.treasury.gov/initiatives/Documents/FinalReport_web.pdf.
5 P.L. 111-203, 124 Stat. 1376 (2010).
6 See “Designation of Non-Banks for Enhanced Prudential Regulation” infra.
7 See “Title II and the Orderly Liquidation Authority” infra.
8 See “Dodd-Frank Section 113 and FSOC Guidance” and “Administrative Rules” infra.
9 See “Criticisms of Title I and Responses” and “Criticisms of Title II and Responses” infra.
10 See “The “Too-Big-To-Fail” Problem” and “TBTF Financial Institutions During the 2007-2009 Financial Crisis”
infra.
11 See “Designation of Non-Banks for Enhanced Prudential Regulation” and “Title II and the Orderly Liquidation
Authority” infra.
12 See “Non-Bank Designations to Date” and “Administrative Rules” infra.

Congressional Research Service

R45162 · VERSION 7 · UPDATED

1

Systemic Risk Regulation of Non-Bank Financial Institutions

provisions and responses,13 and legislative proposals to change them.14 An Appendix to this
report contains a glossary that defines certain key terms in the report.15

The “Too-Big-To-Fail” Problem
When large, interconnected financial institutions become distressed, policymakers often face a
choice between (1) a taxpayer-funded bailout, and (2) the destabilization of the financial
system—a dilemma that commentators have labeled the “too-big-to-fail” (TBTF) problem.16 Two
features of the financial system help explain the origin of the TBTF problem. First, banks and
certain other financial institutions are almost always highly leveraged, meaning that their
shareholder equity is a small fraction of their total assets, and that they accordingly fund their
assets with large amounts of borrowing.17 Second, banks and certain other financial institutions
often fund themselves with large amounts of short-term debt, while investing in longer-term loans
and other illiquid assets—a practice called “maturity transformation.”18 While commentators
generally agree that maturity transformation is socially valuable,19 the process makes financial
13 See “Criticisms of Title I and Responses” and “Criticisms of Title II and Responses” infra.
14 See “Proposals to Alter Title I” and “Proposals to Alter Title II” infra.
15 See Appendix.
16 Randall D. Guynn, Framing the TBTF Problem: The Path to a Solution, in ACROSS THE GREAT DIVIDE: NEW

PERSPECTIVES ON THE FINANCIAL CRISIS 281, 291 (Martin Neil Baily & John B. Taylor eds., 2014). See also RICHARD
SCOTT CARNELL, JONATHAN R. MACEY & GEOFFREY P. MILLER, THE LAW OF FINANCIAL INSTITUTIONS 38 (6th ed. 2017);
CRS Report R42150, Systemically Important or “Too Big to Fail” Financial Institutions, by (name redacted)
; Too Big to
Fail: The Path to a Solution, BIPARTISAN POLICY CENTER (May 2013), http://bipartisanpolicy.org/wp-content/uploads/
sites/default/files/TooBigToFail.pdf [hereinafter “Bipartisan Policy Center Report”].
17 See Harry DeAngelo & René Stulz, Why High Leverage is Optimal for Banks, HARV. L. SCH. FORUM ON CORP. GOV.
AND FIN. REG. (June 27, 2013), https://corpgov.law.harvard.edu/2013/06/27/why-high-leverage-is-optimal-for-banks/.
18 See Guynn, supra note 16 at 291; Lawrence J. White, The Basics of Too Big to Fail, in PERSPECTIVES ON DODDFRANK AND FINANCE 25, 26 (Paul H. Schultz ed., 2014); Daniel R. Fischel, Andrew M. Rosenfield & Robert S.
Stillman, The Regulation of Banks and Bank Holding Companies, 73 VA. L. REV. 301, 306-07 (1987); Douglas W.
Diamond & Philip H. Dybvig, Bank Runs, Deposit Insurance, and Liquidity, 91 J. POL. ECON. 401, 403 (1983).
Customer deposits, many of which are payable on demand (as in most checking accounts), represent major liabilities of
commercial banks, which make loans to businesses and individuals. See CARNELL, ET AL., supra note 16 at 67-78. And
many large investment banks that deal in securities and derivatives obtain short-term financing from commercial paper
and repurchase agreements (repos). White, supra note 18 at 26; DARRELL DUFFIE, HOW BIG BANKS FAIL AND WHAT TO
DO ABOUT IT 29 (2011).
Commercial paper is a short-term, unsecured corporate IOU. CARNELL, ET AL., supra note 16 at 152. By contrast, repos
are transactions pursuant to which one party sells securities to another party for cash, while simultaneously agreeing to
repurchase the same or similar securities at some time in the future at a premium. See Jeanne L. Schroeder, Repo
Madness: The Characterization of Repurchase Agreements under the Bankruptcy Code and the U.C.C., 46 SYRACUSE
L. REV. 999, 1004-1006 (1996). The economic function of a repo is accordingly similar to that of a secured loan. Id. at
1006. Large investment banks often make heavy use of “overnight repos” with a term of one day in order to benefit
from their flexibility and low financing rates. DUFFIE, supra note 18 at 29-30; FINAL REPORT OF THE NAT’L COMM’N ON
THE CAUSES OF THE FIN. AND ECON. CRISIS IN THE U.S. 296-97 (2011) [hereinafter “FINANCIAL CRISIS REPORT”].
Although commentators generally agree that insurance companies “are less likely to pose systemic risk than similarsized banks” because they are “less vulnerable to runs or other liquidity problems,” CARNELL, ET AL., supra note 16 at
671, insurance companies may pose systemic risk when they offer products that allow customers to withdraw assets
with minimal penalties, engage in securities lending and certain other capital markets activities, or when they have
significant financial-guarantee businesses. See Daniel Schwarcz & Steven L. Schwarcz, Regulating Systemic Risk in
Insurance, 81 U. CHI. L. REV. 1569, 1571 (2014); Robert P. Bartlett III, Inefficiencies in the Information Thicket: A
Case Study of Derivatives Disclosures during the Financial Crisis, 36 J. CORP. L. 1, 1-42 (2010).
19 See Edward Simpson Prescott, Introduction to the Special Issue on the Diamond-Dybvig Model, 96 FED. RES. BANK
RICHMOND ECON. Q. 1, 1-2 (2010).

Congressional Research Service

R45162 · VERSION 7 · UPDATED

2

Systemic Risk Regulation of Non-Bank Financial Institutions

institutions vulnerable to liquidity “runs.”20 That is, when a financial institution’s short-term
creditors become concerned about its solvency or liquidity, they have incentives to demand
immediate conversion of their claims into cash,21 or to reduce their exposure in other ways that
force the institution to sell its illiquid assets at significantly discounted prices.22
A “run” on one financial institution can spread to other institutions that do business with it.23
Small banks typically hold deposit balances at larger banks, and large banks, securities firms, and
insurance companies often face significant exposure to one another through their over-the-counter
derivatives portfolios.24 Accordingly, troubles at one financial institution can spread to others,
resulting in additional “runs” and a “contagious panic throughout the financial system that causes
otherwise solvent financial institutions to become insolvent.”25 This type of financial “contagion”
can cause asset price implosions as institutions liquidate assets in order to meet creditor demands,
further impairing their ability to lend and the ability of businesses to raise capital.26 Faced with a
choice between bailouts and economic collapse, policymakers have generally opted for bailouts,27
20 See Guynn, supra note 16 at 291; Jonathan R. Macey & Geoffrey P. Miller, Bank Failures, Risk Monitoring, and the

Market for Bank Control, 88 COLUM. L. REV. 1153, 1156-59 (1988); Fischel, et al., supra note 18 at 307-10; Diamond
& Dybvig, supra note 18 at 401-02.
21 Guynn, supra note 16 at 291; Bipartisan Policy Center Report, supra note 16 at 38-39; ROBERT E. LITAN &
JONATHAN RAUCH, AMERICAN FINANCE FOR THE 21ST CENTURY 98-112 (1997); Fischel, et al., supra note 18 at 307-10.
Commentators have argued that short-term creditors face a classic “prisoner’s dilemma” in which creditors as a group
are often harmed by mass withdrawals that force a financial institution to take value-reducing actions, such as
liquidating loans or securities at distressed prices. Macey & Miller, supra note 20 at 1156-57; Fischel, et al., supra note
18 at 307-10. However, individual creditors have incentives to withdraw their assets from a troubled institution to avoid
being left with nothing. Fischel, et al., supra note 18 at 307-10. Fearing that other creditors will withdraw funds from a
troubled institution, creditors “may rationally adopt a ‘me-first’ attitude and demand payment as soon as possible,”
precipitating a “run.” Id. at 308.
22 In the case of a large investment bank, these exposure-mitigating activities may include, among other things: (1) repo
lenders demanding increased collateral or declining to renew their positions altogether, (2) derivatives counterparties
requesting that other investment banks assume the obligations of a troubled bank (an act referred to as a “novation”),
resulting in the transfer of cash collateral out of the troubled bank, and (3) hedge funds and other prime-brokerage
clients of a troubled bank withdrawing cash from their free credit balances at the bank. See DUFFIE, supra note 18 at 2342.
23 White, supra note 18 at 27; LITAN & RAUCH, supra note 21 at 98-112; Helen A. Garten, Banking on the Market:
Relying on Depositors to Control Bank Risks, 4 YALE J. ON REG. 129, 160-63 (1986).
24 LITAN & RAUCH, supra note 21 at 98-112. A “derivative” is a financial instrument whose value depends on the value
of some other asset, such as a commodity, interest rate, currency, bond, or stock. CARNELL, ET AL., supra note 16 at
871-72. An “over-the-counter” (OTC) derivative is a derivative contract that is “individually negotiated by parties
dealing directly with one another,” as opposed to a derivative contract that is traded on an organized exchange. Id. at
871.
Commentators have observed that the OTC derivatives market is highly concentrated, generating high levels of
systemic risk. See Sheri M. Markose, Systemic Risk from Global Financial Derivatives: A Network Analysis of
Contagion and Its Mitigation with Super-Spreader Tax, INTERNATIONAL MONETARY FUND 8 (2012),
https://www.imf.org/external/pubs/ft/wp/2012/wp12282.pdf (noting that according to a 2009 survey conducted by Fitch
Ratings, “the top 12 counterparties [in the OTC derivatives market] comprised 78 percent of total exposure,” and that
“dependence on a limited number of counterparties looks to be a permanent feature of the market”).
Moreover, as discussed in greater detail in “QFCs” infra, OTC derivatives often provide counterparties with “crossdefault rights”—that is, rights to terminate the contract, set-off obligations, or liquidate collateral based on the
bankruptcy of a party’s parent, subsidiary, or affiliate. The bankruptcy of a financial holding company can accordingly
trigger “runs” on its subsidiaries, and vice versa.
25 Guynn, supra note 16 at 291. See also White, supra note 18 at 27; Bipartisan Policy Center Report, supra note 16 at
39; LITAN & RAUCH, supra note 21 at 98-112.
26 See LITAN & RAUCH, supra note 21 at 98-112.
27 Guynn, supra note 16 at 291 (“All indications from history suggest that when public policymakers, and even the

Congressional Research Service

R45162 · VERSION 7 · UPDATED

3

Systemic Risk Regulation of Non-Bank Financial Institutions

arguably creating incentives for financial institutions to take excessive risks and grow larger than
is socially optimal.28

TBTF Financial Institutions During the
2007-2009 Financial Crisis
The 2007-2009 financial crisis highlighted the significance of the TBTF problem. During that
time, the United States experienced what many commentators believe was the worst financial
crisis since the Great Depression, triggering a severe recession.29 According to many observers, a
principal cause of the crisis was the collapse of a bubble in the housing market that had developed
in the early and mid-2000s.30 As this bubble popped over the course of 2007 and 2008, many
financial institutions experienced large losses related to the real estate market.31
In March 2008, Bear Stearns—the fifth largest American investment bank at the time—informed
the Federal Reserve that it was unable to refinance its short-term debt as a result of a “run” by its
short-term creditors.32 Believing that the bankruptcy of Bear Stearns raised “the potential for
public, are faced with the choice between bailout and collapse or destabilization, they typically choose bailouts rather
than risk a collapse of the system.”); Bipartisan Policy Center Report, supra note 16 at 19 (“Faced with a choice
between bailout and fire-sale liquidations or value-destroying reorganizations that can result in a contagious panic and a
collapse of the financial system, ... policymakers typically choose bailout as the lesser of two evils.”). See also Michael
M. Phillips, Government Bailouts: A U.S. Tradition Dating to Hamilton, WALL ST. J. (Sept. 20, 2008),
https://www.wsj.com/articles/SB122186662036058787.
28 See DUFFIE, supra note 18 at 5 (arguing that knowledge that TBTF institutions will receive government support when
distressed “provides an additional incentive to large financial institutions to take inefficient risks, a well-understood
moral hazard,” and that “[t]he creditors of systemically important financial institutions may offer financing at terms
that reflect the likelihood of a government bailout, thus further encouraging these financial institutions to increase
leverage.”); Bipartisan Policy Center Report, supra note 16 at 43-44 (arguing that if shareholders expect a TBTF
institution to be bailed out, they “will encourage the institutions to engage in excessive risk-taking,” and that bailouts
result in market distortions in the form of “an implicit government subsidy of funding costs,” because “shareholders,
long-term unsecured debt holders and the holders of other capital structure liabilities might accept below-market
returns if they expect the institutions or their claims to be bailed out by the government.”).
29 See Jeff Madrick, The Real Lesson of Lehman, THE N.Y. REVIEW OF BOOKS (Oct. 4, 2014), http://www.nybooks.com/
daily/2014/10/04/real-lesson-lehman-bankruptcy/; Jon Hilsenrath, Serena Ng & Damian Paletta, Worst Crisis Since
‘30s, With No End Yet in Sight, WALL ST. J. (Sept. 18, 2008), https://www.wsj.com/articles/SB122169431617549947;
Heather Stewart, We Are in the Worst Financial Crisis Since Depression, Says IMF, THE GUARDIAN (Apr. 9, 2008),
https://www.theguardian.com/business/2008/apr/10/useconomy.subprimecrisis.
30 FINANCIAL CRISIS REPORT, supra note 18 at 1-4. See also CARNELL, ET AL., supra note 16 at 32; White, supra note 18
at 31; Christopher L. Foote, Kristopher S. Gerardi & Paul S. Willen, Why Did So Many People Make So Many Ex Post
Bad Decisions?: The Causes of the Foreclosure Crisis, in RETHINKING THE FINANCIAL CRISIS 136, 136-40 (Alan S.
Blinder, Andrew W. Lo & Robert M. Solow, eds. 2012).
Commentators have debated the ultimate and proximate causes of the 2007-2009 financial crisis. In analyzing the
crisis, observers have contested the relative roles of financial deregulation, easy monetary policy, government housing
policy, the complexity and opacity of newly-popular financial products, predatory mortgage lending, the concentration
of risk in institutions outside the ambit of traditional banking regulations (the so-called “shadow banking system”), and
government bailout policy, among other things. See Robert E. Litan, The Political Economy of Financial Regulation
after the Crisis, in RETHINKING THE FINANCIAL CRISIS 269, 270 (“There are so many alleged ‘causes’ of the great
financial crisis of 2007 to 2008 that it is easy to lose count.”); FINANCIAL CRISIS REPORT, supra note 18 at 125-26, 187,
230, 255; Dissenting Statement of Keith Hennessy, Douglas Holtz-Eakin & Bill Thomas, in FINANCIAL CRISIS REPORT,
supra note 18 at 413-37; Dissenting Statement of Peter Wallison, in FINANCIAL CRISIS REPORT, supra note 18 at 443553.
31 FINANCIAL CRISIS REPORT, supra note 18 at 279-91.
32 Bear Stearns, JP Morgan Chase, and Maiden Lane LLC, BD. OF GOV. OF THE FED. RES. SYS.,

Congressional Research Service

R45162 · VERSION 7 · UPDATED

4

Systemic Risk Regulation of Non-Bank Financial Institutions

contagion to similarly situated firms,” and the possibility of “serious[] disrupt[ions]” to the
stability of financial markets, the Federal Reserve exercised its authority to lend to non-banks in
“unusual and exigent circumstances” under Section 13(3) of the Federal Reserve Act.33 According
to then-Chairman of the Federal Reserve Ben Bernanke, policymakers “were reasonably sure that
[Bear Stearns’s] unexpected bankruptcy filing would ignite ... panic.”34 A bankruptcy proceeding,
Bernanke explained, could seriously damage the money market funds that lent to Bear Stearns
and other corporations, and “lock up the cash of many other creditors, potentially for years.”35
Likewise, according to Bernanke, unwinding Bear Stearns’s derivatives portfolio would have
“prove[n] chaotic” because of its size and complexity.36 Moreover, a decision by JP Morgan, the
“clearing bank” for Bear Stearns’s repurchase agreements (repos),37 to liquidate collateral on
behalf of Bear Stearns’s creditors could drive securities prices down even further, “leading to a
new wave of losses and write-downs” and possible “runs” on other investment banks.38
Accordingly, on March 14, the Federal Reserve Bank of New York (New York Fed) extended a
bridge loan of $12.9 billion to Bear Stearns as it worked to orchestrate a deal to save the
investment bank.39 On March 17, the Federal Reserve shepherded an acquisition of Bear Stearns
by JP Morgan.40 In order to facilitate the acquisition, the Federal Reserve again exercised its
Section 13(3) authority, creating an entity called Maiden Lane LLC and lending it roughly
$29 billion to purchase certain mortgage assets from Bear Stearns.41
https://www.federalreserve.gov/regreform/reform-bearstearns.htm.
33 See id.; 12 U.S.C. § 343(3) (2006).
34 BEN BERNANKE, THE COURAGE TO ACT: A MEMOIR OF A CRISIS AND ITS AFTERMATH 215 (2015).
35 Id. Money market funds are funds that generally invest in high-quality, liquid, short-term securities and give their
investors the right to withdraw their share of the fund’s assets on demand. CARNELL, ET AL., supra note 16 at 32.
However, unlike commercial banks, money market funds are not required to obtain deposit insurance and do not enjoy
access to the Federal Reserve’s “discount window.” William A. Birdthistle, Breaking Bucks in Money Market Funds,
2010 WISC. L. REV. 1155, 1160-62 (2010). Before the financial crisis, money market funds had become a major source
of short-term financing for major financial institutions and non-financial corporations, accumulating more than $3
trillion in assets. Id. at 1157.
36 BERNANKE, supra note 34 at 215-16.
37 For an explanation of repos, see note 18 supra. Bear Stearns borrowed heavily in the “tri-party” repo market, in
which a clearing bank intermediates between repo lenders and borrowers. Id. at 216. See also Adam Copeland, Darrell
Duffie, Antoine Martin & Susan McLaughlin, Key Mechanics of the U.S. Tri-Party Repo Market, FED. RES. BANK OF
NEW YORK ECON. POL. REV. 17 (Nov. 2012), https://www.newyorkfed.org/medialibrary/media/research/epr/12v18n3/
1210cope.pdf.
The role of clearing banks in the tri-party repo market consists primarily in shifting cash and securities back and forth
between borrowers and lenders. Id. at 6. However, before and during the financial crisis, the two principal clearing
banks (JP Morgan and Bank of New York Mellon) provided borrowers with several hours of “intraday” credit while
arranging their transactions. Id. at 6. Commentators have observed that the large exposure of clearing banks to troubled
repo dealers and to the possibility of sharp declines in the value of the securities that collateralize repos were major
contributors to systemic risk. Id. at 6-7.
38 BERNANKE, supra note 34 at 216. See also TIMOTHY F. GEITHNER, STRESS TEST: REFLECTIONS ON FINANCIAL CRISES
150 (2014) (“[Bear Stearns] was completely unmeshed in the fabric of the system. It had nearly four hundred
subsidiaries. It had trading positions with five thousand counterparties around the world. And it had borrowed about
$80 billion in the tri-party repo market, presenting ... risks of runs on money markets and investment banks.”).
39 See BD. OF GOV. OF THE FED. RES. SYS., supra note 32. This bridge loan was extended to Bear Stearns through JP
Morgan, the clearing bank between Bear Stearns and its repo lenders. Id.; BERNANKE, supra note 34 at 214. The loan
was secured by Bear Stearns assets valued at $13.8 billion and was repaid on March 17, 2008. BD. OF GOV. OF THE FED.
RES. SYS., supra note 32.
40 Id.
41 Id.; BERNANKE, supra note 34 at 219 (explaining that JP Morgan CEO Jamie Dimon “had made clear” that without
government assistance, “the deal would be too big and too risky for JP Morgan”); GEITHNER, supra note 38 at 153

Congressional Research Service

R45162 · VERSION 7 · UPDATED

5

Systemic Risk Regulation of Non-Bank Financial Institutions

Although the Bear Stearns rescue temporarily calmed markets,42 similar troubles surfaced later in
2008 at Lehman Brothers (Lehman), the nation’s fourth largest investment bank at the time.43
Over the weekend of September 12, the New York Fed attempted to coordinate a private-sector
solution that would avert a Lehman bankruptcy.44 During these negotiations, regulators took the
position that no government money would be committed to rescuing Lehman, unlike the case of
Bear Stearns six months earlier.45
The government’s attempts to broker an acquisition of Lehman ultimately failed. Bank of
America, one of the potential acquirers, purchased the also-troubled investment bank Merrill
Lynch instead.46 British regulators of Barclays, another potential purchaser, refused to approve a
proposed deal without a shareholder vote.47 Unable to secure government support or find a private
buyer, Lehman declared bankruptcy on September 15, 2008.48
Lehman’s bankruptcy reverberated throughout financial markets. On September 15, the Dow
Jones Industrial Average dropped more than 500 points, its worst single-day decline in seven
years.49 Shares of Goldman Sachs and Morgan Stanley, two of the largest remaining investment
banks, lost an eighth of their value.50 Lehman’s bankruptcy also precipitated a “run” on money
market funds.51 The Reserve Primary Fund, a large fund that had invested in Lehman’s
commercial paper, “broke the buck,” meaning that its asset value per share fell below $1.52
(explaining that JP Morgan had refused to acquire Bear Stearns without government assistance).
The Maiden Lane transaction was formally structured as a loan to comply with Section 13(3) of the Federal Reserve
Act. However, some commentators have argued that the transaction exceeded the scope of the Federal Reserve’s
Section 13(3) authority because “the primary goal of the transaction was to remove ... assets from Bear Stearns’s
balance sheet,” meaning that it functioned more like an asset purchase (which is not allowed under Section 13(3)) than
a loan. See Alexander Mehra, Legal Authority in Unusual and Exigent Circumstances: The Federal Reserve and the
Financial Crisis, 13 U. PA. J. BUS. L. 221, 238 (2010).
JP Morgan also extended a loan of roughly $1 billion to Maiden Lane LLC, which was subordinated to the loan made
by the Federal Reserve. BD. OF GOV. OF THE FED. RES. SYS., supra note 32. Maiden Lane LLC fully repaid its loans
from the Federal Reserve on June 14, 2012. See Maiden Lane Transactions, FED. RES. BANK OF NEW YORK,
https://www.newyorkfed.org/markets/maidenlane.html#tabs-1.
42 BERNANKE, supra note 34 at 226; FINANCIAL CRISIS REPORT, supra note 18 at 292.
43 FINANCIAL CRISIS REPORT, supra note 18 at 327-31; David Teather, Andrew Clark & Jill Treanor, Barclays Agrees
$1.75bn Deal for Core Lehman Brothers Business, THE GUARDIAN (Sept. 16, 2008), https://www.theguardian.com/
business/2008/sep/17/barclay.lehmanbrothers1.
While troubles at Lehman did not boil over until September 2008, policymakers reportedly “had been pressing [it] to
raise more capital for at least a year.” BERNANKE, supra note 34 at 252. However, because Lehman was an investment
bank, neither the Federal Reserve nor the FDIC had the authority to compel it to raise capital. Id. (“If Lehman had been
a midsize commercial bank, forcing [it] to raise more capital would have been straightforward: Either the company met
the supervisor’s expectations or the FDIC would have taken it over and paid off the depositors as necessary. But neither
the Fed nor the FDIC had the authority to take over Lehman ... Legally, the government’s only alternative, if Lehman
couldn’t find new capital, would have been trying to force the firm into bankruptcy.”).
44 CARNELL, ET AL., supra note 16 at 35.
45 CARNELL, ET AL., supra note 16 at 35; GEITHNER, supra note 38 at 178; FINANCIAL CRISIS REPORT, supra note 18 at
334.
46 FINANCIAL CRISIS REPORT, supra note 18 at 337.
47 Id. at 335-37.
48 CARNELL, ET AL., supra note 16 at 35.
49 BERNANKE, supra note 34 at 270.
50 Id.
51 CARNELL, ET AL., supra note 16 at 35.
52 Id.

Congressional Research Service

R45162 · VERSION 7 · UPDATED

6

Systemic Risk Regulation of Non-Bank Financial Institutions

Because money market investors had come to expect that fund shares would always be worth $1,
the troubles at the Reserve Primary Fund precipitated a $300 billion “run” on other funds,
threatening a key source of short-term financing for large and medium-sized companies.53
Also in September 2008, American International Group (AIG)—the nation’s largest insurance
company at the time—came under heavy financial pressure.54 During the real estate boom, one of
AIG’s affiliates had accumulated significant exposure to the housing market by selling “credit
default swaps” (CDSs) on mortgage bonds, which provided their purchasers with credit
protection in the event that the bonds defaulted.55 On September 15, the day Lehman declared
bankruptcy, AIG suffered a credit rating downgrade that required it to post margin on its CDS
obligations.56 Later that day, AIG informed the New York Fed that it was unable to access the
commercial paper market in order to meet the margin call.57 As it had done with Bear Stearns, the
Federal Reserve invoked its Section 13(3) authority to rescue AIG, reasoning that an AIG
bankruptcy would have devastating effects on the financial system.58 On September 16, the
Federal Reserve announced that it would provide AIG with an $85 billion credit line in exchange
for a 79.9 percent stake in the firm.59
53 Id.; GEITHNER, supra note 38 at 195.
54 CARNELL, ET AL., supra note 16 at 35; FINANCIAL CRISIS REPORT, supra note 18 at 344-52.
55 CARNELL, ET AL., supra note 16 at 35, 50. As an insurance company, AIG’s operations were primarily overseen by

state regulators—specifically, the New York State Insurance Department. FINANCIAL CRISIS REPORT, supra note 18 at
345. However, AIG’s holding company (including its foreign operations and non-insurance businesses) was not subject
to oversight by insurance regulators. BERNANKE, supra note 34 at 271-72. Rather, because AIG’s holding company
owned a small savings-and-loan company, it fell within the regulatory purview of the federal Office of Thrift
Supervision (OTS). Id. Dodd-Frank eliminated the OTS, 12 U.S.C. § 5413, and transferred its functions and powers to
the Office of the Comptroller of the Currency, the FDIC, and the Federal Reserve, id. § 5412.
In addition to losses on its CDS portfolio, AIG also experienced large losses related to its securities lending business.
See Robert McDonald & Anna Paulson, AIG in Hindsight, FED. RES. BANK OF CHICAGO 10-12 (Oct. 2014),
https://www.chicagofed.org/~/media/publications/working-papers/2014/wp2014-07-pdf.pdf. In a securities lending
transaction, one party borrows a security (often as part of a short-selling strategy, or to deliver a security to a customer)
from another party and deposits collateral (typically cash) with the securities lender. Id. at 10. The securities lender
often invests the cash collateral in short-term, highly liquid securities because lending agreements are generally callable
on demand. Id. at 10-11. However, AIG invested a substantial portion of its cash collateral in longer-term, illiquid
assets such as mortgage-backed securities, making it vulnerable to a “run.” Id. at 11. After AIG announced a large
quarterly loss in August 2008, a number of its securities lending counterparties terminated their lending agreements,
forcing AIG to liquidate its longer-term assets at significantly discounted prices. Id. at 11-12.
56 CARNELL, ET AL., supra note 16 at 35.
57 FINANCIAL CRISIS REPORT, supra note 18 at 349.
58 BERNANKE, supra note 34 at 283 (“[AIG’s] failure would create chaos in so many ways: by raising doubts about the
solvency of its creditors and derivative counterparties ... ; by imposing losses on holders of its commercial paper ... ;
and by draining available cash from state funds set up to protect customers of failing insurance companies.”);
GEITHNER, supra note 38 at 191 (“The more our Fed team studied AIG and the insolvency regime for insurers, the less
confidence they had in the potential for an orderly resolution ... Virtually every major financial institution in the world
had some exposure to AIG.”); FINANCIAL CRISIS REPORT, supra note 18 at 350 (quoting a press release from the Federal
Reserve explaining that “a disorderly failure of AIG could add to already significant levels of financial market fragility
and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic
performance.”).
59 FINANCIAL CRISIS REPORT, supra note 18 at 350. David S. Hilzenrath & Glenn Kessler, U.S. Seizes Control of AIG
With $85 Billion Emergency Loan, WASH. POST. (Sept. 17, 2008), http://www.washingtonpost.com/wp-dyn/content/
article/2008/09/16/AR2008091602174_3.html. The Federal Reserve’s loans to AIG were fully repaid in June 2012.
New York Fed Announces Full Repayment of its Loans to Maiden Lane LLC and Maiden Lane III LLC, FED. RES. BANK
OF NEW YORK (June 14, 2012), https://www.newyorkfed.org/newsevents/news/markets/2012/an120614.html.
The reasons why regulators allowed Lehman but not Bear Stearns or AIG to fail remain contested. In the weeks after
Lehman filed for bankruptcy, Bernanke testified that while “[t]he failure of Lehman posed risks,” the bank’s difficulties

Congressional Research Service

R45162 · VERSION 7 · UPDATED

7

Systemic Risk Regulation of Non-Bank Financial Institutions

In the fall of 2008, troubles at other large institutions rocked financial markets. Fannie Mae and
Freddie Mac—government-sponsored enterprises that purchased and guaranteed mortgage loans
and securities—were placed into conservatorships.60 The FDIC took over Washington Mutual, the
nation’s third largest mortgage lender, and sold it to JP Morgan.61 Goldman Sachs and Morgan
Stanley, the two largest remaining investment banks, converted to bank holding companies to
assure themselves continued access to the Federal Reserve’s “discount window,” among other
reasons.62 Numerous European financial institutions suffered “runs.”63 In October 2008, President
George W. Bush signed the Emergency Economic Stabilization Act.64 The Act established the
Troubled Asset Relief Program (TARP),65 pursuant to which the federal government would
eventually disburse over $400 billion in the form of investments in financial institutions and the
automotive industry, among other things.66

“had been well known for some time,” and the market was accordingly prepared to deal with its failure. FINANCIAL
CRISIS REPORT, supra note 18 at 340. Bernanke and then-President of the New York Fed Timothy Geithner have
subsequently asserted that unlike Bear Stearns and AIG, Lehman did not have sufficient collateral to allow the Federal
Reserve to lend pursuant to its Section 13(3) authority. See id.; BERNANKE, supra note 34 at 226, 287-88; GEITHNER,
supra note 38 at 185, 187, 206-07.
This claim has been the subject of much debate. See LAURENCE M. BALL, THE FED AND LEHMAN BROTHERS: SETTING
THE RECORD STRAIGHT ON A FINANCIAL DISASTER (forthcoming, 2018); James B. Stewart & Peter Eavis, Revisiting the
Lehman Brothers Bailout That Never Was, N.Y. TIMES (Sept. 29, 2014), https://www.nytimes.com/2014/09/30/
business/revisiting-the-lehman-brothers-bailout-that-never-was.html; FINANCIAL CRISIS REPORT, supra note 18 at 34041; James Surowiecki, Explaining the Decision to Let Lehman Fail, THE NEW YORKER (Jan. 22, 2009),
https://www.newyorker.com/business/james-surowiecki/explaining-the-decision-to-let-lehman-fail.
Critics of the decision to allow Lehman to fail note that by its terms, Section 13(3) requires only that loans to nonbanks be “secured to the satisfaction of the Federal Reserve,” as opposed to fully secured. FINANCIAL CRISIS REPORT,
supra note 18 at 340-41. The Financial Crisis Inquiry Commission, a ten-member commission charged with
investigating the crisis by the Fraud Enforcement and Recovery Act, P.L. 111-21 (2009), concluded that regulators
declined to rescue Lehman “for a variety of reasons, including the lack of a private firm willing and able to acquire it,
uncertainty about Lehman’s potential losses, concerns about moral hazard and political reaction, and erroneous
assumptions that Lehman’s failure would have a manageable impact on the financial system.” FINANCIAL CRISIS
REPORT, supra note 18 at 343.
60 FINANCIAL CRISIS REPORT, supra note 18 at 309.
61 CARNELL, ET AL., supra note 16 at 35.
62 As Goldman and Morgan Shift, a Wall St. Era Ends, N.Y. TIMES DEALBOOK (Sept. 21, 2008),
https://dealbook.nytimes.com/2008/09/21/goldman-morgan-to-become-bank-holding-companies/. The “discount
window” is the program pursuant to which the Federal Reserve serves as a “lender of last resort,” allowing banks to
borrow in order to meet temporary liquidity needs, generally at a penalty rate of interest. See 12 U.S.C. § 343(2).
During the crisis, the Federal Reserve opened the “discount window” to investment banks. Id. However, the Federal
Reserve had indicated that such access was only temporary when Goldman Sachs and Morgan Stanley converted to
bank holding companies. Id.
63 CARNELL, ET AL., supra note 16 at 35-6.
64 P.L. 110-343, 122 Stat. 3765 (2008).
65 12 U.S.C. § 5211.
66 Jonathan Weisman, U.S. Declares Bank and Auto Bailouts Over, and Profitable, N.Y. TIMES (Dec. 19, 2014),
https://www.nytimes.com/2014/12/20/business/us-signals-end-of-bailouts-of-automakers-and-wall-street.html. See also
TARP Programs, U.S. DEP’T OF THE TREASURY, https://www.treasury.gov/initiatives/financial-stability/TARPPrograms/Pages/default.aspx.

Congressional Research Service

R45162 · VERSION 7 · UPDATED

8

Systemic Risk Regulation of Non-Bank Financial Institutions

The troubles in the financial system also spilled over to the real economy. U.S. households lost an
estimated 26 percent of their wealth ($17 trillion) between mid-2007 and early 2009.67 And
between 2008 and December 2009, the economy lost an estimated 8.3 million jobs.68
In response to the crisis, Congress passed and President Obama signed the Dodd-Frank Wall
Street Reform and Consumer Protection Act of 2010 (Dodd-Frank),69 legislation that some
commentators characterized as “the most ambitious overhaul of financial regulation in
generations.”70 Among other things, Dodd-Frank reformed certain aspects of securities and
derivatives markets,71 imposed a variety of requirements related to mortgage standards,72 and
created a new federal agency tasked with consumer financial protection (the Consumer Financial
Protection Bureau).73 Other portions of Dodd-Frank are specifically directed at the systemic risk
created by TBTF financial institutions. In order to minimize the risks that large financial
institutions like Lehman and AIG fail, Title I of Dodd-Frank establishes an enhanced prudential
regulatory regime for certain large bank holding companies and non-bank financial companies.74
And in order to resolve systemically important financial institutions in the event that they
nevertheless experience financial distress, Title II establishes a new resolution regime available
for such institutions outside of the Bankruptcy Code.75 The remaining sections of this report
discuss the legal issues raised by Titles I and II, their implementation by federal regulatory
agencies, and proposals to reform them.

Title I: Enhanced Prudential Standards for
Systemically Important Financial Institutions
Regulators have traditionally relied upon a variety of tools to minimize the risks of financial
institution failures. In order to reduce the risk of insolvency, regulators have imposed capital
requirements on commercial and investment banks.76 In order to reduce depositors’ incentives to
67 William R. Emmons & Bryan J. Noeth, Household Financial Stability: Who Suffered the Most from the Crisis?, FED.

RES. BANK OF ST. LOUIS (July 2012), https://www.stlouisfed.org/publications/regional-economist/july-2012/householdfinancial-stability—who-suffered-the-most-from-the-crisis#endnotes.
68 FINANCIAL CRISIS REPORT, supra note 18 at 390.
69 P.L. 111-203, 124 Stat. 1376 (2010).
70 Brady Dennis, Congress passes financial reform bill, WASH. POST. (July 16, 2010), http://www.washingtonpost.com/
wp-dyn/content/article/2010/07/15/AR2010071500464.html.
71 15 U.S.C. § 78o-11; P.L. 111-203, tit. VII, XVI. See also CRS Legal Sidebar LSB10077, The Half Trillion Dollar
Ruling: Latest Dodd-Frank Case Narrows “Skin-in-the-Game” Rule, by (name redacted)
.
72 P.L. 111-203, tit. XIV.
73 Id. tit., X. For a high-level overview of Dodd-Frank, see CRS Report R41350, The Dodd-Frank Wall Street Reform
and Consumer Protection Act: Background and Summary, coordinated by (name redacted)
.
74 P.L. 111-203, tit. I.
75 Id., tit. II.
76 See 12 C.F.R. part 3, appendix A (imposing capital requirements on national banks), § 208.4(a) (imposing capital
requirements on members of the Federal Reserve System), part 217 (imposing capital requirements on bank holding
companies), parts 324-325 (imposing capital requirements on institutions insured by the Federal Deposit Insurance
Corporation); 17 C.F.R. § 240.15c3-1(a) (imposing capital requirements on securities brokers and dealers). See also
CARNELL, ET AL., supra note 16 at 204-14, 238-66.
Federal regulators have also imposed liquidity requirements on commercial banks. See 12 C.F.R. part 50 (imposing
liquidity requirements on national banks), part 249 (imposing liquidity requirements on members of the Federal
Reserve System), part 329 (imposing liquidity requirements on institutions insured by the Federal Deposit Insurance
Corporation). Likewise, state insurance regulators have adopted capital requirements and limitations on permissible

Congressional Research Service

R45162 · VERSION 7 · UPDATED

9

Systemic Risk Regulation of Non-Bank Financial Institutions

“run,” regulators require all commercial banks to obtain minimum levels of deposit insurance
from the Federal Deposit Insurance Corporation (FDIC).77 In order to address liquidity problems,
the Federal Reserve has the authority to serve as a “lender of last resort” by making “discount
window” loans to commercial banks.78 Moreover, the Federal Reserve can lend to non-banks in
“unusual and exigent circumstances” pursuant to its authority under Section 13(3) of the Federal
Reserve Act.79 However, as the 2007-2009 financial crisis arguably demonstrated, sometimes
these measures have proven insufficient to prevent financial institution failures.
In response to these concerns, Title I of Dodd-Frank establishes an enhanced prudential
regulatory regime for certain large financial institutions.80 Specifically, the Title I regime applies
to (1) all bank holding companies with total consolidated assets of $50 billion or more, and (2)
any non-bank financial companies81 that the Financial Stability Oversight Council (FSOC)82
investments for insurance companies. See CARNELL, ET AL., supra note 16 at 658-59.
77 See 12 C.F.R. § 5.20(e)(3); MICHAEL S. BARR, HOWELL E. JACKSON & MARGARET E. TAHYAR, FINANCIAL
REGULATION: LAW AND POLICY 166 (2016).
78 See 12 U.S.C. § 343(2). Ordinarily, the volume of “discount window” lending is low because (1) the Federal Reserve
generally charges a “penalty” interest rate, and (2) obtaining “discount window” loans from the Federal Reserve may
be stigmatizing. See CARNELL, ET AL., supra note 16 at 221. However, during a crisis, the Federal Reserve often lowers
the penalty rate of interest and accepts collateral that it might reject in normal times. Id.
79 See 12 U.S.C. § 343(3) (2006). While not the focus of this report, the Federal Reserve’s use of its emergency lending
power to lend to non-banks during the 2007-2009 financial crisis generated controversy, leading to certain changes to
Section 13(3) of the Federal Reserve Act. See generally CRS Report R44185, Federal Reserve: Emergency Lending, by
(name redacted)
; Mehra, supra note 41. Specifically, Dodd-Frank provides that (1) the Treasury Secretary must approve
any loans made by the Federal Reserve pursuant to its Section 13(3) authority, (2) such loans may be made only as part
of “a program or facility with broad-based eligibility,” as opposed to only specific firms, and (3) the security for any
such loans must be sufficient to protect taxpayers from losses. See 12 U.S.C. § 343(3).
80 12 U.S.C. § 5365.
81 Title I defines a “nonbank financial company” as a “U.S. nonbank financial company” or “foreign nonbank financial
company.” Id. § 5311(a)(4)(C). A “U.S. nonbank financial company” is a company (other than a banking holding
company, Farm Credit System institution, national securities exchange, clearing agency, security-based swap execution
facility, security-based swap data repository, or derivatives clearing organization) that is (1) incorporated under the
laws of the United States or any state, and (2) predominantly engaged in financial activities. Id. § 5311(a)(4)(B). A
“foreign nonbank financial company” is a company (other than a bank holding company) that is (1) incorporated or
organized in a country other than the United States, and (2) predominantly engaged in financial activities. Id.
§ 5311(a)(4)(A).
A company is “predominantly engaged” in financial activities if (1) the annual gross revenues derived by the company
and all of its subsidiaries related to activities that are “financial in nature” represents 85 percent or more of the
consolidated gross revenues of the company, or (2) the consolidated assets of the company and all of its subsidiaries
related to activities that are “financial in nature” represent 85 percent or more of the consolidated gross revenues of the
company. Id. § 5311(a)(6).
For purposes of this definition, the following activities (among others) are considered “financial in nature”: (1) lending,
exchanging, transferring, investing for others, or safeguarding money or securities, (2) insuring, guaranteeing, or
indemnifying against loss, harm, damage, illness, disability, or death, or providing and issuing annuities, and acting as
principal, agent, or broker for purposes of the foregoing, (3) providing financial, investment, or economic advisory
services, (4) issuing or selling instruments representing interests in pools of assets permissible for a bank to hold
directly, (5) underwriting, dealing in, or making a market in securities. See id. § 1843(k)(4).
82 FSOC is an umbrella regulatory body created by Dodd-Frank, whose voting members consist of the heads of nine
federal regulatory agencies and an independent insurance expert. Id. § 5321(a)-(b). FSOC’s voting members are the
heads of the Federal Reserve Board of Governors, Federal Deposit Insurance Corporation, Office of the Comptroller of
the Currency, Commodity Futures Trading Commission, Securities and Exchange Commission, National Credit Union
Administration, Federal Housing Finance Agency, Consumer Financial Protection Bureau, and an independent
insurance expert. Id. § 5321(b)(1). FSOC also includes five non-voting members: the director of the Office of Financial
Research, the director of the Federal Insurance Office, a state banking supervisor, a state insurance commissioner, and
a state securities regulator. Id. § 5321(b)(2).

Congressional Research Service

R45162 · VERSION 7 · UPDATED

10

Systemic Risk Regulation of Non-Bank Financial Institutions

designates as systemically important.83 Section 165 of Dodd-Frank directs the Federal Reserve to
impose prudential standards on these institutions that “are more stringent than” those applicable
to other bank holding companies and non-bank financial companies, and that “increase in
stringency” based on certain statutorily-prescribed considerations.84 These enhanced standards
include
risk-based capital requirements and leverage limits;85
liquidity requirements;86
overall risk management requirements;87
a requirement that the relevant companies develop resolution plans (so-called
“living wills”) describing how they can be rapidly resolved in the event of
material distress or failure;88 and
5. credit exposure reporting requirements.89
1.
2.
3.
4.

Congress is currently considering whether to change the first basis for imposition of enhanced
prudential regulations on financial institutions—the automatic $50 billion threshold for bank
holding companies.90 That policy question is addressed in another recent Congressional Research
Service report.91 This section of the report accordingly provides a legal overview of (1) FSOC’s
process for designating non-banks as systemically important and FSOC’s designations to date, (2)
criticisms of FSOC’s designation process and responses, and (3) proposals to reform FSOC’s
designation process.

Designation of Non-Banks for Enhanced Prudential Regulation
Dodd-Frank Section 113 and FSOC Guidance
As discussed, during the 2007-2009 financial crisis, troubles at certain non-bank financial firms
(such as Lehman and AIG) “contributed to a broad seizing up of financial markets and stress at
other financial firms.”92 Accordingly, in the aftermath of the crisis, the Obama Administration
The statutory purposes of FSOC are to (1) identify risks to the financial stability of the United States, (2) promote
market discipline by eliminating expectations of government bailouts, and (3) respond to emerging threats to the
stability of the United States financial system. Id. § 5322(a)(1). For a more detailed overview of FSOC’s structure and
authorities, see CRS Report R45052, Financial Stability Oversight Council (FSOC): Structure and Activities, by (name re
dacted) .
83 Id. § 5365(a)(1).
84 Id.
85 Id. § 5365(b)(1)(A)(i).
86 Id. § 5365(b)(1)(A)(ii).
87 Id. § 5365(b)(1)(A)(iii).
88 Id. § 5365(d)(1).
89 Id. § 5365(b)(1)(A)(iv). For an overview of the Federal Reserve’s implementation of these enhanced prudential
standards, and legislative proposals to change Dodd-Frank’s $50 billion threshold for enhanced supervision for bank
holding companies, see CRS Report R45036, Bank Systemic Risk Regulation: The $50 Billion Threshold in the DoddFrank Act, by (name redacted) and (name redacted).
90 The Economic Growth, Regulatory Relief, and Consumer Protection Act, S. 2155, 115th Cong. (2017), which passed
the Senate on March 14, 2018, would raise this threshold to $250 billion.
91 See Labonte & Perkins, supra note 89.
92 Final Rule and Interpretive Guidance, Authority to Require Supervision and Regulation of Certain Nonbank
Financial Companies, 70 Fed. Reg. 21,637, 21,637 (Apr. 11, 2012) [hereinafter “Non-Bank Designation Rule”].

Congressional Research Service

R45162 · VERSION 7 · UPDATED

11

Systemic Risk Regulation of Non-Bank Financial Institutions

proposed creating a council to identify non-bank financial companies whose failure could pose a
threat to financial stability and subjecting them to consolidated supervision by the Federal
Reserve irrespective of their legal structure.93 Section 113 of Dodd-Frank implemented this
recommendation, creating FSOC and granting it the authority to designate certain non-bank
financial companies for enhanced supervision by the Federal Reserve.94
Section 113 provides that FSOC may, by a vote of at least two-thirds of its voting members
(which must include the Treasury Secretary in the majority), designate non-bank financial
companies as systemically important under either of two standards:
1. when “material financial distress” at a non-bank financial company “could pose a
threat to the financial stability of the United States,” or
2. when the “nature, scope, size, scale, concentration, interconnectedness, or mix of
the [non-bank financial company’s] activities” could pose that same threat.95
In making such a designation, FSOC must consider, among any other risk-related factors that
FSOC deems appropriate, the following factors:












the company’s leverage;
the extent and nature of its off-balance-sheet exposures;
the extent and nature of the transactions and relationships of the company with
other significant nonbank financial companies and significant bank holding
companies;
the importance of the company as a source of credit for low-income, minority, or
underserved communities, and the impact that the failure of such company would
have on the availability of credit in such communities;
the extent to which assets are managed rather than owned by the company, and
the extent to which ownership of assets under management is diffuse;
the nature, scope, size, scale, concentration, interconnectedness, and mix of the
activities of the company;
the degree to which the company is already regulated by 1 or more primary
financial regulatory agencies;
the amount and nature of the financial assets of the company;
the amount and types of the liabilities of the company, including the degree of
reliance on short-term funding.96

Dodd-Frank requires that FSOC provide a non-bank financial company with written notice of a
proposed systemic risk designation, including an explanation for the basis of the proposed
determination.97 A non-bank that receives a notice of a proposed determination has 30 days to
request an opportunity for a written or oral hearing before FSOC to contest the proposed
93 FINANCIAL REGULATORY REFORM: A NEW FOUNDATION, U.S. DEP’T OF THE TREASURY 20 (Oct. 8, 2009),

https://www.treasury.gov/initiatives/Documents/FinalReport_web.pdf.
94 12 U.S.C. § 5323(a)(1). Dodd-Frank does not use the term “systemically important” to describe non-banks subject to
enhanced supervision. However, for purposes of brevity, this report will refer to such institutions as “systemically
important.”
95 Id.
96 Id. § 5323(a)(2).
97 Id. § 5323(e)(1).

Congressional Research Service

R45162 · VERSION 7 · UPDATED

12

Systemic Risk Regulation of Non-Bank Financial Institutions

determination, and FSOC has 60 days after such hearing to notify the non-bank financial
company of its final determination.98 Once that determination is made, the designated non-bank is
subject to the enhanced prudential regulatory regime.
A designated company can then seek judicial review of FSOC’s final determination within 30
days in either the U.S. district court for the judicial district in which its home office is located, or
in the U.S. District Court for the District of Columbia.99 The court’s review is limited to whether
FSOC’s determination was “arbitrary and capricious,”100 a standard pursuant to which a court
evaluates whether an agency:
has relied on factors which Congress has not intended it to consider, entirely failed to
consider an important aspect of the problem, offered an explanation for its decision that
runs counter to the evidence before the agency, or is so implausible that it cannot be
ascribed to a difference in view of the product of agency expertise.101

FSOC is required to annually re-evaluate systemic risk designations for non-bank financial
companies and may rescind such designations upon a vote of two-thirds of its voting members
that includes the Treasury Secretary.102
In April 2012, FSOC issued guidance concerning the Title I designation process and standards for
non-banks.103 In the guidance, FSOC organized the 10 statutory factors guiding systemic risk
designations into six “categories” of considerations:
1. interconnectedness;
2. substitutability (i.e., the extent to which other firms could timely provide similar
financial services at a similar price and quantity if a non-bank financial company
withdrew from a particular market);
3. size;
4. leverage;
5. liquidity risk and maturity mismatch; and
6. existing regulatory scrutiny.104
FSOC explained that the first three categories “seek to assess the potential for spillovers from [a]
firm’s distress,” while the remaining three categories “seek to assess how vulnerable a company
is to financial distress.”105
The guidance further provided that FSOC intends to assess how a non-bank’s financial stress
could be transmitted to other firms or markets through any of three “transmission channels”:
1. exposure (i.e., the extent to which creditors, counterparties, investors, or other
market participants are exposed to the company);
98 Id. § 5323(e)(2)-(3). Upon a two-thirds vote that includes the Treasury Secretary, FSOC may waive these

requirements if it determines “that such waiver or modification is necessary or appropriate to prevent or mitigate threats
posed by the nonbank financial company to the financial stability of the United States.” Id. § 5323(f)(1).
99 Id. § 5323(h).
100 Id.
101 Motor Vehicles Mfrs. v. State Farm Mut. Auto. Ins., 463 U.S. 29, 43 (1983).
102 12 U.S.C. § 5323(d).
103 Non-Bank Designation Rule, supra note 92.
104 Id. at 21,641.
105 Id.

Congressional Research Service

R45162 · VERSION 7 · UPDATED

13

Systemic Risk Regulation of Non-Bank Financial Institutions

2. asset liquidation (i.e., whether the company holds assets that, if liquidated
quickly, would cause a fall in asset prices); and
3. critical function or service (i.e., whether the company provides a critical function
or service that is relied upon by market participants and for which there are no
ready substitutes).106
The FSOC guidance also outlined a three-stage process for systemic risk designations.107 FSOC
explained that during Stage 1, it will apply “a set of uniform quantitative metrics ... to a broad
group” of non-bank financial companies in order to identify companies “for further
evaluation.”108 According to the guidance, during Stage 2, FSOC will apply “a wide range of
quantitative and qualitative information” about the companies identified in Stage 1, and “begin
the consultation process” with the company’s “primary financial regulatory agencies or home
country supervisors.”109 After Stage 2 is completed, companies selected for additional review are
notified that they are being considered for designation as systemically important.110 Finally,
during Stage 3, FSOC will evaluate information collected from the company under consideration,
in addition to information considered during Stages 1 and 2, and will decide whether to make a
proposed determination that the company be subject to enhanced supervision.111

Non-Bank Designations to Date
To date, FSOC has designated four non-bank financial companies for enhanced supervision: AIG,
General Electric Capital Corporation (GE Capital), Prudential Financial (Prudential), and
MetLife.112 However, FSOC later rescinded the designations of two of these entities—AIG and
GE Capital—based on changed circumstances at those companies.113 Further, MetLife
successfully challenged its designation by FSOC in federal district court, leaving Prudential as the
only non-bank financial company subject to the enhanced prudential regulatory regime at the time
of publication of this report.114 The following subsections of the report discuss the designations of
each of these institutions as illustrations of how FSOC has implemented its designation authority.

106 Id.
107 Id. at 21,660.
108 Id.
109 Id.
110 Id.
111 Id. In February 2015, FSOC issued additional supplemental procedures relating to its designations of non-banks for

enhanced supervision. See Fin. Stability Oversight Council Supplemental Procedures Relating to Nonbank Financial
Company Determinations, U.S. DEP’T OF THE TREASURY (Feb. 4, 2015), https://www.treasury.gov/initiatives/fsoc/
designations/Documents/
Supplemental%20Procedures%20Related%20to%20Nonbank%20Financial%20Company%20Determinations%20%20February%202015.pdf. FSOC indicated that pursuant to the supplemental procedures, it will notify a non-bank
financial company within 30 days after it forms an analytical team to commence active review of a company in Stage 2
(as opposed to after the company is advanced to Stage 3). Id. at 2. A company under active review in Stage 2 may
submit to FSOC any information it deems relevant, and may meet with FSOC’s analytical team. Id. FSOC also
indicated that it intends to publicly confirm a company’s announcement that it is under active review in Stage 2, or that
it has been advanced to Stage 3. Id. at 4.
112 See Designations, FIN. STABILITY OVERSIGHT COUNCIL, U.S. DEP’T OF THE TREASURY, https://www.treasury.gov/
initiatives/fsoc/designations/Pages/default.aspx (last visited Apr. 9, 2018).
113 See “AIG” and “GE Capital” infra.
114 See “Prudential” and “MetLife” infra.

Congressional Research Service

R45162 · VERSION 7 · UPDATED

14

Systemic Risk Regulation of Non-Bank Financial Institutions

AIG
FSOC designated AIG for enhanced supervision in July 2013.115 In designating AIG, FSOC
explained that although a large number of the company’s insurance products (such as life
insurance and annuities) are intended to be long-term liabilities, many also contain “features that
could make them vulnerable to rapid and early withdrawals by policyholders.”116 FSOC further
explained that if AIG were to encounter sufficiently severe stress, “funds from products allowing
for early withdrawals might be withdrawn regardless of the size of associated surrender charges
or tax penalties,” forcing AIG to “liquidate a substantial portion of its large portfolio of relatively
illiquid corporate and foreign bonds, as well as asset-backed securities.”117 Such an asset
liquidation could, in FSOC’s view, have disruptive effects on financial markets and “cause
financial contagion if the negative sentiment and uncertainty associated with material distress at
AIG spread[] to other insurers.”118 FSOC also concluded (1) that “[a] large number of corporate
and financial entities have significant exposures to AIG,”119 (2) that because AIG was the leading
commercial insurance underwriter in the U.S., its exit from the marketplace “could reduce the
availability and affordability of certain insurance products,”120 and (3) that AIG’s “highly
complex” interstate and cross-border structure complicated its resolvability, further aggravating
the effects that its financial distress could have on financial stability.121 AIG did not contest
FSOC’s designation.122
After an annual re-evaluation required by Dodd-Frank, FSOC voted to rescind its designation of
AIG in September 2017.123 In rescinding its designation, FSOC explained that AIG had reduced
the amounts of its total debt, short-term debt, derivatives portfolio, securities lending, repos, and
total assets.124 FSOC further indicated that additional analyses conducted for the purposes of its
re-evaluation, “including additional consideration of the effects of incentives and disincentives
for [AIG’s] policyholders to surrender their life insurance policies and annuities,” indicated “that
there is not a significant risk that a forced asset liquidation by AIG would disrupt market
functioning.”125 FSOC also noted that AIG had sold certain businesses, “reduced its multijurisdictional operations, simplified its legal structure, and reduced its size and global footprint,”
making it “notably different from the company as it existed leading up to the financial crisis.”126

115 Basis of the Financial Stability Oversight Council’s Final Determination Regarding American International Group,

Inc., U.S. DEP’T OF THE TREASURY (July 8, 2013), https://www.treasury.gov/initiatives/fsoc/designations/Documents/
Basis%20of%20Final%20Determination%20Regarding%20American%20International%20Group,%20Inc.pdf.
116 Id. at 2.
117 Id.
118 Id. at 2-3.
119 Id. at 6.
120 Id. at 8.
121 Id. at 10-11.
122 Id. at 1.
123 Notice and Explanation of the Basis for the Financial Stability Oversight Council’s Rescission of Its Determination
Regarding American International Group, Inc. (AIG), U.S. DEP’T OF THE TREASURY (Sept. 29, 2017),
https://www.treasury.gov/initiatives/fsoc/designations/Documents/American_International_Group,_Inc._
(Rescission).pdf.
124 Id. at 5.
125 Id.
126 Id. at 5, 7.

Congressional Research Service

R45162 · VERSION 7 · UPDATED

15

Systemic Risk Regulation of Non-Bank Financial Institutions

GE Capital
On the same day it designated AIG for enhanced supervision, FSOC similarly designated GE
Capital, a savings-and-loan holding company and wholly owned subsidiary of the General
Electric Company.127 In designating GE Capital, FSOC explained that the company was one of
the largest financial holding companies in the United States and “a significant source of credit to
the U.S. economy.”128 FSOC further observed that large global banks and non-bank financial
companies had significant exposure to GE Capital through their purchase of its commercial paper
and long-term debt, and provision of backup lines of credit.129 Financial distress at GE Capital,
FSOC reasoned, could trigger “runs” on money market funds that would in turn “impair the
ability of financial and other firms to fund their operations.”130 FSOC also concluded that GE
Capital’s interstate and cross-border structure, coupled with its intercompany funding and shared
service agreements, complicated its resolvability.131 GE Capital did not contest FSOC’s
designation.132
After an annual re-evaluation required by Dodd-Frank, FSOC rescinded its designation of GE
Capital in June 2016, explaining that since its designation, GE Capital had “fundamentally
changed its business ... [t]hrough a series of divestitures, a transformation of its funding model,
and a corporate reorganization.”133 Moreover, FSOC noted that since its designation, GE Capital
had decreased its total assets by more than 50 percent, shifted away from short-term debt, and
reduced its interconnectedness with large financial institutions.134 Finally, FSOC observed that as
a result of divestitures and changes to its business, GE Capital no longer owned any U.S.
depository institutions, nor did it provide financing to consumers or small business customers.135

Prudential
Slightly less than two months after designating AIG and GE Capital, FSOC designated
Prudential, a large financial services company and one of the largest U.S. insurers, for enhanced
supervision.136 In designating Prudential, FSOC explained that “[c]orporations, banks, and
pension plans have exposures to Prudential through retirement and pension products, corporateand bank-owned life insurance, and other group insurance products.”137 Moreover, FSOC
127 Basis of the Financial Stability Oversight Council’s Final Determination Regarding General Electric Capital

Corporation, Inc., U.S. DEP’T OF THE TREASURY (July 8, 2013), https://www.treasury.gov/initiatives/fsoc/designations/
Documents/
Basis%20of%20Final%20Determination%20Regarding%20General%20Electric%20Capital%20Corporation,%20Inc.p
df.
128 Id. at 2.
129 Id.
130 Id.
131 Id. at 10-11.
132 Id. at 1.
133 Basis of the Financial Stability Oversight Council’s Rescission of Its Determination Regarding GE Capital Global
Holdings, LLC, U.S. DEP’T OF THE TREASURY (June 28, 2016), https://www.treasury.gov/initiatives/fsoc/designations/
Documents/GE%20Capital%20Public%20Rescission%20Basis.pdf.
134 Id. at 2.
135 Id.
136 Basis of the Financial Stability Oversight Council’s Final Determination Regarding Prudential Financial, Inc., U.S.
DEP’T OF THE TREASURY (Sept. 19, 2013), https://www.treasury.gov/initiatives/fsoc/designations/Documents/
Prudential%20Financial%20Inc.pdf.
137 Id. at 2.

Congressional Research Service

R45162 · VERSION 7 · UPDATED

16

Systemic Risk Regulation of Non-Bank Financial Institutions

reasoned that Prudential’s capital market activities—specifically, its derivatives activities, use of
credit lines from large banks, securities lending, and reverse repo portfolio—further “expand[ed]
its connections to other financial firms and markets.”138As with AIG, FSOC reasoned that if
Prudential faced pressure to rapidly liquidate its illiquid assets to meet withdrawals, securities
markets could face significant disruptions, and other insurance companies could face “runs” of
their own triggered by heightened uncertainty.139 FSOC also concluded that because of its multistate and cross-border operations, and because there was “no precedent for the resolution of an
insurance company the size and scale of Prudential,” the company would likely be difficult to
resolve in an orderly fashion.140 Prudential requested a hearing to contest FSOC’s proposed
determination, and FSOC made its final determination after reviewing Prudential’s written
submissions and holding an oral hearing.141
As a result of FSOC’s rescission of its designations of AIG and GE Capital, and a decision by the
U.S. District Court for the District of Columbia overturning MetLife’s designation (discussed in
“MetLife” infra), Prudential remains the only non-bank financial company designated for
enhanced supervision as of the publication of this report. However, in February 2018, Prudential
announced that FSOC was in the process of conducting its annual review of its designation, and
that the company intended to make its case that it does not meet the statutory standards for
designation.142

MetLife
Over a year after its designation of Prudential, FSOC designated MetLife, another large insurance
company, for enhanced supervision.143 MetLife’s designation came after a lengthy engagement
process that reportedly included 12 meetings between FSOC and the company’s representatives,
the submission of over 21,000 pages of materials to FSOC, and an oral hearing challenging
FSOC’s proposed determination.144 In designating MetLife, FSOC reasoned that MetLife’s
financial distress “could lead to an impairment of financial intermediation or financial market
functioning that could be sufficiently severe to inflict significant damage on the economy.”145
Specifically, FSOC reasoned that large financial intermediaries had significant exposure to
MetLife because of its institutional products and capital market activities, such as funding
agreements, guaranteed investment contracts, pension closeouts, and securities lending
agreements.146 Moreover, as with AIG and Prudential, FSOC concluded that a large-scale forced
liquidation of MetLife’s assets could disrupt securities markets.147 FSOC also reasoned that

138 Id.
139 Id. at 2-3.
140 Id. at 12.
141 Id. at 1.
142 Michelle Price & Pete Schroeder, U.S. Financial Regulatory Panel to Review Prudential Risk Designation, REUTERS

(Feb. 15, 2018), https://www.reuters.com/article/us-usa-fsoc/u-s-financial-regulatory-panel-to-review-prudential-riskdesignation-idUSKCN1FZ291.
143 Basis for the Financial Stability Oversight Council’s Final Determination Regarding MetLife, Inc., U.S. DEP’T OF
THE TREASURY (Dec. 18, 2014), https://www.treasury.gov/initiatives/fsoc/designations/Documents/
MetLife%20Public%20Basis.pdf.
144 Id. at 2-3.
145 Id. at 15.
146 Id. at 16.
147 Id.

Congressional Research Service

R45162 · VERSION 7 · UPDATED

17

Systemic Risk Regulation of Non-Bank Financial Institutions

MetLife’s interstate and cross-border operations complicated its resolvability, further
exacerbating the effects its distress might have on financial stability.148
MetLife proceeded to challenge FSOC’s decision before the U.S. District Court for the District of
Columbia, which invalidated FSOC’s determination in March 2016.149 In holding that FSOC’s
determination was “arbitrary and capricious,” the court explained that by assessing only the
potential impact of MetLife’s financial distress, and not MetLife’s vulnerability to financial
distress, FSOC had violated its April 2012 guidance, which indicated that FSOC would consider
both issues and divided its “categories” of analysis accordingly.150
The court also concluded that FSOC had failed to abide by its April 2012 guidance—which
provided that a non-bank financial company could threaten financial stability only “if there would
be an impairment of financial intermediation or of financial market functioning that would be
sufficiently severe to inflict significant damage on the broader economy”151—by failing to project
“what the losses would be, which financial institutions would have to actively manage their
balance sheets, or how the market would destabilize as a result” of MetLife’s distress.152 Instead,
the court observed, FSOC had only “summed gross potential market exposures” to MetLife in
conducting its “transmission channel” analysis, without analyzing the extent to which MetLife’s
creditors were secured or other mitigating factors.153
In arriving at this conclusion, the court acknowledged that counterparties’ gross exposure to
MetLife is relevant to the second statutory standard for designation—that a company’s “nature,
scope, size, scale, concentration, interconnectedness, or mix of ... activities” alone “could pose a
threat to” financial stability.154 However, it interpreted FSOC’s explanation for its designation as
relying on only the first statutory standard, which allows for designation when “material financial
distress” at a non-bank financial company “could pose a threat to the financial stability of the
United States.”155 Because FSOC’s guidance had provided that this standard requires a finding
that a firm’s financial distress would impair financial market functioning to a degree sufficient to
inflict significant damage on the broader economy, and FSOC had not adequately supported that
finding, the court held that its determination was arbitrary and capricious.156
Finally, the court held that FSOC’s designation of MetLife was arbitrary and capricious because
FSOC failed to consider the costs of its designation (which MetLife alleged ran in the “billions of
dollars”)—a consideration that it explained is “essential to reasoned rulemaking.”157
Although FSOC initially appealed the district court’s decision to the U.S. Court of Appeals for
the D.C. Circuit, it filed a motion to dismiss the appeal in January 2018, which the court granted,
ending the case.158
148 Id. at 29-30.
149 MetLife, Inc. v. Financial Stability Oversight Council, 177 F. Supp. 3d 219 (2016).
150 Id. at 233-36.
151 Id.
152 MetLife, Inc., 177 F. Supp. 3d at 237.
153 Id.
154 MetLife, Inc., 177 F. Supp. 3d at 238.
155 Id.
156 Id.
157 Id. at 239-42.
158 See MetLife, Inc. v. Financial Stability Oversight Council, No. 16-5086, 2018 WL 1052618 (D.C. Cir. Jan. 23,

2018).

Congressional Research Service

R45162 · VERSION 7 · UPDATED

18

Systemic Risk Regulation of Non-Bank Financial Institutions

Criticisms of Title I and Responses
Title I and FSOC’s process for designating non-banks as systemically important have attracted
some criticism. Some commentators have criticized FSOC for failing to provide firms under
consideration with meaningful, specific information about the criteria used in determining
whether a firm is systemically important.159 Relatedly, some observers have questioned the rigor
of FSOC’s analysis of companies under consideration for designation.160 Others have raised
concerns about the transparency of the designation process.161 Finally, some commentators have
criticized FSOC for not considering the costs of designations in conducting its analyses—a
criticism echoed in the district court’s decision overturning FSOC’s designation of MetLife.162
In response, defenders of FSOC have argued that the “malleable standard[s]” FSOC applies in
determining whether companies qualify as systemically important effectively deter companies
from seeking out systemically risky activities.163 According to this line of argument, the adoption
of precise mathematical formulas for distinguishing between safe and risky companies would
159 See Andy Winkler, Primer: FSOC’s SIFI Designation Process for Nonbank Financial Companies, AM. ACTION

FORUM (Sept. 3, 2014), https://www.americanactionforum.org/research/primer-fsocs-sifi-designation-process-fornonbank-financial-companies/; Peter J. Wallison, What the FSOC’s Prudential Decision Tells Us About SIFI
Designation, AM. ENTER. INST. (Mar. 31, 2014), http://www.aei.org/publication/what-the-fsocs-prudential-decisiontells-us-about-sifi-designation/ (arguing that FSOC has “failed to develop or implement any intelligible standard for
determining whether a particular firm is” systemically important).
Relatedly, in 2014, a group of plaintiffs challenged the constitutionality of the provisions in Title I allowing FSOC to
designate non-banks as systemically important, arguing that the level of discretion afforded FSOC violated the
separation of powers. See Second Amended Complaint for Declaratory and Injunctive Relief ¶ 8, State Nat. Bank of
Big Spring v. Lew, 958 F. Supp. 127 (D.D.C. 2013). To establish standing, a plaintiff-bank contended that it was
harmed by FSOC’s designation of GE Capital (a competitor) for enhanced regulation because that designation
allegedly conferred reputational benefits upon GE Capital. State Nat. Bank of Big Spring v. Lew, 795 F.3d 48, 55 (D.C.
Cir. 2015). The U.S. Court of Appeals for the D.C. Circuit rejected that argument and affirmed an order dismissing the
plaintiff’s claims for lack of standing, reasoning that the doctrine of competitor standing does not apply in cases where
a challenged regulation increases a competitor’s regulatory burdens. Id.
160 See Wallison, supra note 159 (noting that in its designation of Prudential, FSOC concluded that Prudential’s failure
would have “significant” effects on financial markets and counterparties, but “made no effort to support its
characterizations with the kind of numerical data that would give the word some meaning”); Resolution Approving
Final Determination Regarding Prudential Financial, Inc., Views of the Council’s Independent Member having
Insurance Expertise, U.S. DEP’T OF THE TREASURY at 6 (Sept. 19, 2013), https://www.treasury.gov/initiatives/fsoc/
council-meetings/Documents/September%2019%202013%20Notational%20Vote.pdf (dissenting from FSOC’s
designation of Prudential, and contending that FSOC’s explanation of its designation “does not contain any analysis
that presents any findings as to severe impairment of financial intermediation; severe impairment of the functioning of
U.S. and global financial markets; or resulting significant damage to the economy. No empirical evidence is presented;
no data is reviewed; no models are put forward.”).
161 See Dodd-Frank’s Missed Opportunity: A Road Map for a More Effective Regulatory Architecture, BIPARTISAN
POLICY CENTER at 41 (April 2014), https://bipartisanpolicy.org/wp-content/uploads/sites/default/files/BPC%20DoddFrank%20Missed%20Opportunity.pdf (concluding that “[t]he use of more open forums to discuss FSOC business
would ... be helpful,” and arguing that “FSOC should also consider releasing additional details about the closed-door
conversations that occur during their regular meetings”); U.S. GOV’T ACCOUNTABILITY OFFICE, GAO-12-886, NEW
COUNCIL AND RESEARCH OFFICE SHOULD STRENGTHEN THE ACCOUNTABILITY AND TRANSPARENCY OF THEIR DECISIONS
55, (Sept. 2012), https://www.gao.gov/assets/650/648064.pdf (noting that public information on FSOC’s decisionmaking is limited, and recommending that FSOC keep detailed records of closed-door sessions and develop a strategy
for improving communication with the public).
162 See MetLife, Inc., 177 F. Supp. 3d at 238; Winkler, supra note 159.
163 Daniel Schwarcz & David Zaring, Regulation by Threat: Dodd-Frank and the Nonbank Problem, 84 U. CHI. L. REV.
1813, 1834 (2017); Simon Johnson & Antonio Weiss, The Financial Stability Oversight Council: An Essential Role for
the Evolving US Financial System, PETERSON INST. FOR INT’L ECON. 10 (May 2017), https://piie.com/system/files/
documents/pb17-20.pdf.

Congressional Research Service

R45162 · VERSION 7 · UPDATED

19

Systemic Risk Regulation of Non-Bank Financial Institutions

encourage companies to seek out activities with risks that are not adequately reflected in such
rigid standards.164 These commentators contend that vesting FSOC with “broad discretion” to
designate firms as systemically important is appropriate given the inherent difficulty of
identifying systemic risks and the perils of failing to identify such risks.165 Moreover, in
responding to arguments that it should consider the costs of designations, FSOC has argued that
because Dodd-Frank’s statutory text does not require such analysis, it need not engage in that
inquiry.166

Proposals to Alter Title I
Proposed Legislation
A number of bills that would alter FSOC’s authority to designate non-banks for enhanced
regulation have been introduced in the 115th Congress. The Financial CHOICE Act of 2017, as
passed by the House of Representatives in June 2017, would repeal FSOC’s authority to
designate non-banks for enhanced regulation altogether.167 H.R. 4061, the Financial Stability
Oversight Council Improvement Act of 2017, which was reported out of the House Committee on
Financial Services in March 2018, proposes more limited changes to FSOC’s authority.168
Specifically, H.R. 4061 would require FSOC to consider “the appropriateness of the imposition of
prudential standards as opposed to other forms of regulation to mitigate the identified risks” in
determining whether to designate a non-bank as systemically important.169 The bill would further
require that FSOC provide designated companies with the opportunity to submit written materials
contesting their designation during FSOC’s annual reevaluation process.170 If FSOC determines
during a re-evaluation that a designation should not be rescinded, the bill would require it to
provide notice to the designated company “address[ing] with specificity” how it assessed the
relevant statutory factors in light of the company’s written submissions.171

The Trump Administration’s Views
In November 2017, the Trump Administration’s Treasury Department released a report outlining
four general recommendations for reforming FSOC’s process for designating non-banks as
systemically important.172 First, the report recommended that FSOC adopt an “activities-based”
164 Schwarcz & Zaring, supra note 163 at 1856. See also Johnson & Weiss, supra note 163 at 10 (“[F]irms considered

for designation are, by definition, large multifaceted financial institutions, and only a holistic approach to assessing risk
can be effective. Any fixed list of criteria would be easy to game, and there are not likely to be one or two easy ‘fixes’
for avoiding designation.”).
165 Schwarcz & Zaring, supra note 163 at 1817. See also Written Testimony of Adam J. Levitin, Hearing on The
Administrative State v. The Constitution: Dodd-Frank at Five Years Before the Subcomm. on the Constitution of the S.
Comm. on the Judiciary, 114th Cong. 8 (July 23, 2015) (statement of Adam. J. Levitin, Professor of Law, Georgetown
University Law Center), https://www.judiciary.senate.gov/imo/media/doc/07-23-15%20Levitin%20Testimony.pdf.
(“SIFI designation is not an unfettered exercise of discretion. Instead, it requires consideration of no less than eleven
detailed factors, as well as an ultimate finding about the nature of risks posed by a firm to the economy.”).
166 See MetLife, Inc., 177 F. Supp. 3d at 238.
167 H.R. 10, 115th Cong. § 151 (2017).
168 H.R. 4061, 115th Cong. (2017).
169 Id. § 2.
170 Id.
171 Id.
172 FIN. STABILITY OVERSIGHT COUNCIL DESIGNATIONS, U.S. DEP’T OF THE TREASURY (Nov. 17, 2017),

Congressional Research Service

R45162 · VERSION 7 · UPDATED

20

Systemic Risk Regulation of Non-Bank Financial Institutions

or “industry-wide” approach to assessing potential risks posed by non-banks.173 Under this
approach, FSOC would prioritize identifying specific financial activities and products that could
pose risks to financial stability, work with the primary financial regulatory agencies to address
those specific risks, and consider individual firms for designation as systemically important only
as a matter of last resort if more limited actions aimed at mitigating discrete risks are insufficient
to safeguard financial stability.174
Second, the Treasury Department recommended that FSOC “increas[e] the analytical rigor” of its
designation analyses.175 Specifically, the Report recommended that FSOC: (1) consider any
factors that might mitigate the exposure of a firm’s creditors and counterparties to its financial
distress; (2) focus on “plausible” (and not merely “possible”) asset liquidation risks; (3) evaluate
the likelihood that a firm will experience financial distress before evaluating how that distress
could be transmitted to other firms; (4) consider the benefits and costs of designations; and
(5) collapse its three-stage review process into two steps, notifying companies that they are under
active review during Stage 1 and voting on proposed designations after the completion of Stage
2.176
Third, the Treasury Department recommended enhancing engagement between FSOC and
companies under review, and improving the designation process’s transparency.177 Specifically,
the report recommended that FSOC: (1) engage earlier with companies under review and “explain
... the key risks” that FSOC has identified, (2) “undertake greater engagement” with companies’
primary financial regulators, and (3) publicly release explanations of its designation decisions.178
Fourth, the Treasury Department recommended that FSOC provide “a clear off-ramp” for nonbanks designated as systemically important.179 The report recommended that FSOC: (1) highlight
the key risks that led to a company’s designation, (2) “adopt a more robust and transparent
process for its annual reevaluations” that “make[s] clear how companies can engage with FSOC
... and what information companies should submit during a reevaluation,” (3) “develop a process
to enable a designated company to discuss potential changes it could make to address the risks it
could pose to financial stability,” and (4) “make clear that the standard it applies in its annual
reevaluations is the same as the standard for an initial designation of a nonbank financial
company.”180 FSOC has yet to act on these recommendations.

Title II: Orderly Liquidation Authority
While Title I of Dodd-Frank is aimed at minimizing the likelihood that systemically important
financial institutions experience financial distress, Title II is directed at resolving such institutions
in a rapid and orderly fashion in the event that they nevertheless become distressed. To
accomplish this goal, Title II establishes a new resolution regime available for systemically
important financial institutions outside of the Bankruptcy Code.181 The following sections of the
https://www.treasury.gov/press-center/press-releases/Documents/PM-FSOC-Designations-Memo-11-17.pdf.
173 Id. at 10.
174 Id. at 19-21.
175 Id. at 22.
176 Id. at 22-29.
177 Id. at 29.
178 Id. at 29-34.
179 Id. at 34.
180 Id. at 34-36.
181 P.L. 111-203, 124 Stat. 1376, tit. II. (2010).

Congressional Research Service

R45162 · VERSION 7 · UPDATED

21

Systemic Risk Regulation of Non-Bank Financial Institutions

report discuss Title II and proposals for its reform. First, the report provides an overview of the
resolution mechanisms available for financial institutions before Dodd-Frank. Second, the report
discusses Title II’s legislative history and the new resolution authority that it establishes. Third,
the report canvasses a variety of administrative rules with important implications for Title II.
Fourth, the report discusses certain criticisms of Title II, and responses to those criticisms.
Finally, the report discusses proposals to repeal or change Title II.

Pre-Dodd-Frank Resolution Mechanisms: Bankruptcy vs.
FDIC Resolution
Commercial banks, broker-dealers, and insurance companies are subject to different insolvency
regimes. Commercial banks must utilize a special resolution regime administered by the FDIC.182
Before Dodd-Frank, broker-dealers and bank holding companies were limited to the Bankruptcy
Code.183 Finally, before Dodd-Frank, insurance companies were limited to state law insolvency
proceedings.184
The purpose and mechanics of bankruptcy and the FDIC’s resolution regime differ in important
respects.185 A non-bank corporation may generally file a voluntary bankruptcy petition with the
clerk of a federal bankruptcy court,186 or the company’s creditors can file a petition for
involuntary bankruptcy if certain conditions are met.187 By contrast, a bank’s chartering agency,
primary federal regulator, or the FDIC initiates the bank resolution process based upon one or
more statutorily-established grounds, including a bank’s undercapitalization.188 Accordingly, a
182 12 U.S.C. § 1821(c)-(d). See also 11 U.S.C. § 109 (specifying which entities are eligible to declare bankruptcy

under the Bankruptcy Code); CARNELL, ET AL., supra note 16 at 397-446.
Commentators have adduced a number of considerations favoring a special insolvency regime for commercial banks,
including, among other things: (1) banks’ importance to the nation’s money supply, payments system, and
macroeconomy, (2) banks’ vulnerability to “runs,” and (3) the fact that bank assets can be transferred quickly and
cheaply. See Robert R. Bliss & George G. Kaufman, U.S. Corporate and Bank Insolvency Regimes: A Comparison and
Evaluation, 2 VA. L. & BUS. REV. 143, 147-48 (2007).
183 See 11 U.S.C. §§ 741-753; Wolkowitz v. FDIC (In re Imperial Credit Indus., Inc.), 527 F.3d 959, 962 (9th Cir.
2008). Broker-dealers are not eligible for Chapter 11 reorganizations and may only be liquidated pursuant to Chapter 7.
Id. § 109(d). Under the Securities Investor Protection Act of 1970, the Securities Investor Protection Corporation
(SIPC) may file an application to stay bankruptcy proceedings of a broker that is an SIPC member to allow the SIPC
liquidate the broker. 15 U.S.C. § 78eee. For an overview of differences between Chapter 7 liquidations and Chapter 11
reorganizations, see CRS Report R45137, Bankruptcy Basics: A Primer, by (name redacted), at 9-14.
184 See CARNELL, ET AL., supra note 16 at 659-71.
185 See Lewis, supra note 183; Richard M. Hynes & Steven D. Walt, Why Banks are Not Allowed in Bankruptcy, 67
WASH. & LEE L. REV. 985, 987 (2010); Bliss & Kaufman, supra note 182 at 153-54.
186 See 11 U.S.C. § 301; FED. R. BANKR. P. 1002(a). But see 11 U.S.C. § 109 (limiting which entities are eligible to be a
debtor under the Bankruptcy Code).
187 See 11 U.S.C. § 303; FED. R. BANKR. P. 1003.
188 See 12 U.S.C. §§ 203(a), 1821(c). The Office of the Comptroller of the Currency serves as the chartering agency for
national banks, while state banking agencies serve as the chartering agencies for state-chartered banks. See Bliss &
Kaufman, supra note 182 at 156 n.44. State-chartered banks are required to obtain deposit insurance from the FDIC
and can become members of the Federal Reserve System. See BARR ET AL., supra note 77 at 166; 12 U.S.C. § 321.
Accordingly, the FDIC serves as the primary federal regulator for state-chartered banks that are not members of the
Federal Reserve System. For a discussion of the architecture of bank regulation in the United States, see CRS Report
R44918, Who Regulates Whom? An Overview of the U.S. Financial Regulatory Framework, by (name redacted)
.
The statutorily-established grounds for appointment of a receiver or conservator are: (1) the insufficiency of a bank’s
assets to service its obligations, (2) the “substantial dissipation” of assets due to a violation of law or “any unsafe or
unsound practice,” (3) “[a]n unsafe or unsound condition to transact business,” (4) the willful violation of a final ceaseand-desist order, (5) concealment of the bank’s books or records from its regulators, (6) likelihood that a bank will be

Congressional Research Service

R45162 · VERSION 7 · UPDATED

22

Systemic Risk Regulation of Non-Bank Financial Institutions

bank need not have defaulted on any outstanding obligations or be deemed insolvent for an
involuntary resolution to begin.189
Corporate bankruptcies are usually resolved in special federal bankruptcy courts.190 In a Chapter
7 bankruptcy, a court appoints an agent such as a trustee to coordinate the insolvency process.191
In a bankruptcy reorganization, the insolvent corporation’s management is generally allowed to
continue operating the company192 and has exclusive rights to develop a reorganization plan for a
period of 120 days after the petition is filed, which may be extended under certain
circumstances.193 Many of the trustee or management’s decisions—for example, to release
collateral to secured creditors, pay employees, and obtain debtor-in-possession financing (i.e.,
financing used to keep the company operating as a going concern)—are subject to court
approval.194 Moreover, any reorganization plan is subject to the unanimous agreement of a
company’s creditors unless the court determines that certain conditions are met.195 These and
other decisions by the bankruptcy court are reviewable by higher courts.196
By contrast, bank resolutions are handled in administrative proceedings conducted by the
FDIC.197 When the FDIC commences administrative resolution proceedings, it generally removes
a bank’s senior management without notice or a hearing and assumes control of the bank.198 The
FDIC unilaterally makes decisions related to the liquidation (pursuant to a receivership) or
continued operation (pursuant to a conservatorship) of the failed bank.199 For FDIC resolutions of
unable to pay its obligations or meet its depositors’ demands, (7) the incurring or likelihood that a bank will incur
losses that will deplete all or substantially all of its capital, (8) any violation of law that is likely to cause insolvency or
a substantial dissipation of assets, weaken the bank’s condition, or otherwise seriously prejudice the bank’s depositors
or the Deposit Insurance Fund, (9) consent to the appointment of a conservator or receiver, (10) failure to maintain
deposit insurance, (11) undercapitalization, with no reasonable prospect of becoming adequately capitalized, failure to
become adequately capitalized when required to do so, failure to submit a required capital restoration plan, or material
failure to implement a capital restoration plan, (12) “critical[]” undercapitalization or otherwise having “substantially
insufficient capital,” or (13) notification from the Attorney General that the bank has been found guilty of certain
criminal money laundering offenses. 12 U.S.C. § 1821(c)(5).
189 See Stanley V. Ragalevsky & Sarah J. Ricardi, Anatomy of a Bank Failure, 126 BANKING L. J. 867, 870 (2009);
Bliss & Kaufman, supra note 182 at 156.
190 See Bliss & Kaufman, supra note 182 at 156. But see 28 U.S.C. § 157(b)(5), (c)(1), (d) (specifying bankruptcyrelated matters that may or must be resolved by a federal district court rather than a bankruptcy court).
191 11 U.S.C. §§ 701-704. Corporate liquidations are governed by Chapter 7 of the Bankruptcy Code, id. § 701, while
reorganizations are governed by Chapter 11, id. § 1101.
192 See id. § 1107. But see id. §§ 1104, 1108 (specifying circumstances under which a bankruptcy court may “order the
appointment of a trustee” to administer a Chapter 11 debtor).
193 Id. § 1121.
194 Id. §§ 363-366.
195 See Bliss & Kaufman, supra note 182 at 159-60; 11 U.S.C. § 1129.
196 FED. R. APP. P. 6; 28 U.S.C. § 158.
197 See Bliss & Kaufman, supra note 182 at 159-60; 11 U.S.C. §§ 109(b)(2), (d) (providing that banks are ineligible for
bankruptcy).
198 See Bliss & Kaufman, supra note 182 at 159-60. Although a bank’s directors have the right to judicial review of a
decision to appoint a conservator or receiver, 12 U.S.C. § 1821(c)(7), commentators have observed that “[t]his right
appears to have been rarely exercised and never successfully,” Bliss & Kaufman, supra note 182 at 160 n.62. See also
Thomas W. Merrill & Margaret L. Merrill, Dodd-Frank Orderly Liquidation Authority: Too Big for the Constitution?,
163 U. PA. L. REV. 165, 179 (2014) (noting that although judicial review of the FDIC’s decision to appoint a receiver is
authorized by statute, it is “extremely difficult” to persuade a court to unwind a receivership).
199 See Bliss & Kaufman, supra note 182 at 159-60. While the FDIC can resolve a bank by a receivership (in which the
FDIC liquidates and winds up of the affairs of a failed bank) or a conservatorship (in which the FDIC continues to
operate a bank as a going concern), 12 U.S.C. §§ 1821(c)-(d), the FDIC has rarely used conservatorships to resolve

Congressional Research Service

R45162 · VERSION 7 · UPDATED

23

Systemic Risk Regulation of Non-Bank Financial Institutions

a commercial bank, there is no separate oversight authority analogous to the relationship between
the bankruptcy court and trustee or management, and there is no mechanism for creditors,
management, or shareholders to participate in the resolution process beyond filing claims and
providing requested information.200 While some of the FDIC’s decisions during this process are
subject to judicial review, others—including decisions to disallow creditor claims that are not
proved to the FDIC’s satisfaction—are not reviewable.201
Bankruptcy and FDIC resolution also differ with respect to how creditors can be temporarily
prevented from pursuing their claims against an insolvent debtor. In bankruptcy, creditors are
temporarily barred from pursuing many of their claims by an “automatic stay” that is effective
upon the filing of a bankruptcy petition,202 and bankruptcy courts have the authority to impose
certain additional stays to ensure an orderly reorganization.203 However, a variety of financial
contracts—including certain securities and commodities contracts, swaps, forwards, and repos—
are exempt from the Bankruptcy Code’s automatic stay.204 Often, such contracts provide that
certain rights—for example, to terminate the contract, net obligations, or liquidate collateral—are
triggered by a party’s entry into bankruptcy (direct default rights) or by the entry into bankruptcy
of a party’s parent or affiliate (cross-default rights).205 Because of the Bankruptcy Code’s “safe
harbor” provisions, such rights can be exercised immediately upon the filing of a bankruptcy
petition, notwithstanding the automatic stay.206
By contrast, while the FDIC lacks general power to stay enforcement of a failed bank’s
contracts,207 it has broad power to disaffirm or repudiate certain contracts if it determines that
performance would be “burdensome,” and that disaffirmance or repudiation would “promote the
orderly administration of the institution’s affairs.”208 Moreover, counterparties to “qualified
financial contracts” (QFCs)—a term defined to include certain securities or commodities
contracts, swaps, forwards, and repos209—with a bank in an FDIC resolution are barred from
exercising direct default rights against the bank based on its entry into resolution proceedings for

failed banks, see Hynes & Walt, supra note 185 at 987 n.3.
200 See Hynes & Walt, supra note 185 at 989; Bliss & Kaufman, supra note 182 at 159-60.
201 See 12 U.S.C. § 1821(d)(5)(E) (providing that decisions to disallow creditor claims are not reviewable).
202 11 U.S.C. § 362. See also Lewis, supra note 183 at 6-8.
203 Id. § 105(a); In re Keene Corp., 164 B.R. 844, 849 (Bankr. S.D.N.Y. 1994).
204 11 U.S.C. §§ 362(b)(6), (7), (17), (27), 362(o), 555-56, 559-61.
Commentators have proffered a variety of arguments for and against exempting such contracts from the automatic stay.
See Mark D. Sherrill, In Defense of the Bankruptcy Code’s Safe Harbors, 70 BUS. LAW. 1007 (2015); Stephen J.
Lubben, Derivatives and Bankruptcy: The Flawed Case for Special Treatment, 12 U. PA. J. BUS. L. 61 (2009); Franklin
R. Edwards & Edward R. Morrison, Derivatives and the Bankruptcy Code: Why the Special Treatment?, 22 YALE J. ON
REG. 91 (2005).
Some observers have argued that the legislative history behind the relevant safe-harbor provisions suggests that
Congress was concerned that the inability of derivatives counterparties to exit contracts with a bankrupt company
contributed to systemic risk by preventing counterparties from mitigating their exposure to the company. Edwards &
Morrison, supra note 204 at 107-08.
205 Final Rule, Restrictions on Qualified Financial Contracts of Certain FDIC-Supervised Institutions; Revisions to the
Definition of Qualifying Master Netting Agreement and Related Definitions, 82 Fed. Reg. 50,228, 50,231 (Oct. 30,
2017).
206 11 U.S.C. §§ 362(b)(6), (7), (17), (27), 362(o), 555-56, 559-61.
207 See Bliss & Kaufman, supra note 182 at 157.
208 12 U.S.C. § 1821(e)(1).
209 Id. § 1821(e)(8)(D)(i).

Congressional Research Service

R45162 · VERSION 7 · UPDATED

24

Systemic Risk Regulation of Non-Bank Financial Institutions

one business day.210 If the FDIC transfers a QFC to another party (as it often does when it sells a
bank’s assets to a healthy acquirer), default rights under the QFC are permanently stayed.211
Accordingly, banks enjoy greater protection against “runs” by their derivatives counterparties in
an FDIC resolution than do non-bank corporations in bankruptcy.
Finally, bankruptcy and FDIC resolution differ with respect to the legal priority of creditors. The
Bankruptcy Code provides a list of priorities specifying the order in which creditors are to be
paid.212 During a Chapter 11 reorganization, the “absolute priority rule” bars the approval of a
reorganization plan that awards property to a junior class of unsecured creditors while failing to
compensate a dissenting class of senior creditors in full.213 A bankrupt firm can also obtain
debtor-in-possession financing during a reorganization, which enjoys priority over certain prebankruptcy debts.214
By contrast, if the FDIC is unable to find a healthy bank to purchase a failing bank in a “purchase
and assumption” transaction (the most common method of resolving a failed bank), it generally
liquidates the bank, paying off insured depositors and issuing receivership certificates to
uninsured depositors and other general creditors.215 The FDIC pays uninsured depositors and
general creditors according to a statutorily prescribed priority scheme.216 In paying these
creditors, the FDIC is required to use the “least costly” resolution method—that is, the resolution
method that minimizes expenditures from the deposit insurance fund.217 However, the FDIC can
waive the least-cost resolution requirement if the Treasury Secretary (in consultation with the
President and with the recommendation of the Federal Reserve) determines that adhering to that
requirement “would have serious adverse effects on economic conditions or financial stability”
and that alternative action “would avoid or mitigate such adverse effects.”218 Although there is no
210 Id. § 1821(e)(10)(B)(i)-(ii). This stay is limited to direct default rights—that is, rights against the bank in

receivership triggered by its placement into receivership. There are no limitations on a counterparty’s cross-default
rights—that is, rights against a bank’s affiliate triggered by the bank’s entry into receivership.
211 Id.
212 11 U.S.C. § 507.
213 See id. § 1129(b)(2)(B)(ii); Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 202 (1988). Some courts have
recognized a “new value exception” to the absolute priority rule, according to which junior creditors can receive
property in a reorganization plan when they provide new value to the debtor. See In re Abeinsa Holding, Inc., 562 B.R.
265, 277 (Bankr. D. Del. 2016).
214 See Bliss & Kaufman, supra note 182 at 162.
A bankruptcy trustee can also claw back or “avoid” certain preferential pre-bankruptcy transfers. 11 U.S.C. §§ 546-47,
555-56, 559-61. By contrast, bank insolvency law does not contain a mechanism for clawing back preferential
transfers. Bliss & Kaufman, supra note 182 at 164. However, the FDIC may claw-back fraudulent transfers made
within five years of a bank’s closure. 12 U.S.C. § 1821(d)(17).
215 See Ragalevsky & Ricardi, supra note 189 at 876.
216 12 U.S.C. § 1821(d)(11).
217 Id. § 1823(c)(4).
218 Id. § 1823(c)(4)(G). The FDIC invoked this “systemic risk exception” multiple times during the 2007-2009 financial
crisis. In September 2008, the FDIC announced that Citigroup would acquire Wachovia’s banking operations in a
transaction assisted by the FDIC. CRISIS AND RESPONSE: AN FDIC HISTORY, 2008-2013 69 (2017). Specifically, the
FDIC agreed to share future losses with Citigroup on a pre-identified pool of $312 billion in loans, in exchange for $12
billion in preferred stock and warrants. Id. at 75. This deal was ultimately abandoned, however, when Wells Fargo
agreed to acquire all of Wachovia’s operations without FDIC assistance. Id. at 76.
The FDIC again invoked the “systemic risk exception” in November 2008 to assist Citigroup. Id. at 82. Pursuant to this
authority, the FDIC (in conjunction with the Treasury Department, acting pursuant to a program established under the
Troubled Asset Relief Program) issued an asset guarantee for a selected pool of $306 billion of Citigroup’s assets, in
exchange for $7 billion in preferred stock paying an 8 percent annual dividend. Id. at 83.

Congressional Research Service

R45162 · VERSION 7 · UPDATED

25

Systemic Risk Regulation of Non-Bank Financial Institutions

external debtor-in-possession financing during an FDIC resolution, the FDIC can offer “open
bank assistance” (OBA) to a troubled bank in the form of a loan, an assumption of some or all of
its liabilities, a purchase of troubled assets, or a direct infusion of capital.219 However, OBA is
“rarely used” because of the least-cost resolution requirement, among other reasons.220
Table 1. Differences Between Bankruptcy and FDIC Resolution
Bankruptcy

FDIC Resolutions

Where are proceedings held?

Bankruptcy court (with certain
exceptions).

Administrative proceedings before
the FDIC.

What are the bases for
commencing an involuntary
resolution?

Among other requirements, a
debtor must be “generally not
paying ... debts” as they become
due.

The FDIC may involuntarily seize a
bank for a variety of reasons,
including a bank’s
undercapitalization.

What happens to old
management?

In a Chapter 11 reorganization,
management is generally permitted
to continue running the company,
and has exclusive rights to develop
a reorganization plan for a period of
120 days after the bankruptcy
petition is filed. In a Chapter 7
liquidation, a trustee generally
replaces old management and
liquidates the debtor.

The FDIC generally removes old
management.

How can creditors participate?

Creditors have several avenues by
which they can participate in a
bankruptcy proceeding. Creditors
can object if the debtor takes
certain actions outside the ordinary
course of business, and impaired
creditors can generally vote on
proposed reorganization plans.

Creditors are generally limited to
submitting their claims and other
requested information to the FDIC.

Are debtors protected against
“runs” by derivatives
counterparties?

Generally not. Certain derivatives
contracts are exempt from the
“automatic stay.”

Yes. QFC counterparties are stayed
from exercising direct default rights
for one business day, and are
permanently stayed from exercising
such rights if the FDIC transfers a
QFC to a third party.

Source: CRS.

The FDIC invoked the “systemic risk exception” once more in January 2009 to assist Bank of America, which had
acquired Merrill Lynch the previous September. Id. at 86. Pursuant to this authority, the FDIC (again in conjunction
with the Treasury Department) issued an asset guarantee for a selected pool of $118 billion of loans, securities, and
other assets, in exchange for $4 billion in preferred stock and warrants. Id. at 90-91.
In addition to invoking the “systemic risk exception” to assist individual troubled banks during the financial crisis, the
FDIC also adopted the then-novel interpretation that the “systemic risk exception” allowed it to take actions to preserve
the stability of the banking system more generally. See id. at 33-60. Pursuant to this interpretation of its authority, the
FDIC implemented the Temporary Liquidity Guarantee Program, which (1) provided a limited-term guarantee for
certain newly-issued debt of commercial banks, thrifts, and financial holding companies and eligible bank affiliates,
and (2) fully guaranteed certain non-interest bearing transaction deposit accounts. Id. at 33.
219 See Ragalevsky & Ricardi, supra note 189 at 882; Bliss & Kaufman, supra note 182 at 162.
220 See Ragalevsky & Ricardi, supra note 189 at 882.

Congressional Research Service

R45162 · VERSION 7 · UPDATED

26

Systemic Risk Regulation of Non-Bank Financial Institutions

These differences between the Bankruptcy Code and FDIC resolution reflect the different
priorities of their respective insolvency schemes. According to many commentators, corporate
bankruptcy is principally focused on maximizing creditor recovery by preserving the “goingconcern” value of a firm, or equitably distributing its assets in the event of a liquidation.221
Accordingly, the Bankruptcy Code gives a firm’s creditors a prominent role in the insolvency
process, allowing them to vote on proposed reorganization plans if their interests are impaired,222
and subjecting a trustee or management’s decisions to judicial scrutiny.223
Bank resolution, by contrast, arguably places greater emphasis on financial stability than does the
Bankruptcy Code, making the speed of the resolution process especially important.224
Accordingly, authority over bank resolution is highly concentrated in one actor: the FDIC. With
its considerable resolution powers, the FDIC is often able to seize a failed bank at the close of
business on a Friday, sell many of its assets, and re-open many of its offices under the auspices of
a healthy acquirer by the following Monday, minimizing negative effects on the financial
system.225
This dual-track insolvency system, with the FDIC in charge of resolving commercial banks and
bankruptcy courts tasked with non-bank insolvencies, arguably functioned effectively for much of
the 20th century.226 However, many commentators have contended that the bankruptcy system is
ill-suited for the resolution of large, complex financial institutions.227 Specifically, observers have
noted that the dependence of such institutions on short-term, highly liquid funding leaves them
susceptible to “runs”—a problem exacerbated by the Bankruptcy Code’s “safe harbor” provisions
for certain derivatives contracts.228 Moreover, commentators have argued that the complicated
legal structures of large financial institutions make their resolution in bankruptcy difficult,
because such institutions often (1) have regulated subsidiaries such as banks and insurance
companies that are not themselves eligible for bankruptcy, and (2) operate their businesses

221 See Bliss & Kaufman, supra note 182 at 153.
222 11 U.S.C. § 1126(a), (f); FED. R. BANKR. P. 3018.
223 See Hynes & Walt, supra note 185 at 1006.
224 Id. at 1007-08.
225 Id. at 989.
226 See Ending “Too Big to Fail”: Title II of the Dodd-Frank Act and the Approach of “Single Point of Entry” Private

Sector Recapitalization of a Failed Financial Company, THE CLEARING HOUSE 12 (Jan. 2013), https://www.cov.com/
files/Publication/714f0b24-8047-4d79-825f-55f5d1e80bdc/Presentation/PublicationAttachment/f7462820-7d03-4ed28b75-96b917418d8f/White_Paper_Ending_Too-Big-to-Fail.pdf. [hereinafter “Clearing House Report”] (arguing that
the “bifurcated regimes worked well for a range of institutions” before the financial crisis, and that “the bank failure
regime administered by the FDIC proved to be very effective in dealing in an orderly way with the wave of depository
institution failures of the 1980s and 1990s”); Sheila Bair, Beyond Bankruptcy and Bailouts, WALL ST. J. (Apr. 5, 2010),
https://www.wsj.com/articles/SB10001424052702304871704575159643688328442 (asserting that “the FDIC has a
well-established process that works for failing banks”); Thomas H. Jackson, Chapter 11F: A Proposal for the Use of
Bankruptcy to Resolve Financial Institutions 217, 217 in ENDING GOVERNMENT BAILOUTS AS WE KNOW THEM
(Kenneth E. Scott, George P. Schultz & John B. Taylor, eds. 2009) (asserting that “[b]ankruptcy reorganization is, for
the most part, an American success story”).
227 See Adam J. Levitin, Bankruptcy’s Lorelei: The Dangerous Allure

[Text truncated at 120,000 characters. The full text is on the page linked above.]

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/crs%3AR45162. Public record. Not legal advice.