[author: Christi R. Adams]

Legislation was introduced in Congress August 2, 2012 that would prevent the Federal Reserve from designating nonbanks as systemically significant. This bill is significant, because it in effect prevents the Federal Reserve from supervising insurance companies and other nonbanks. Under Dodd Frank, nonbank entities that are designated as systemically important are subject to the Federal Reserve’s rules governing capital, contingency and succession planning (“living wills”). Entities designated as systemically significant are also subject to the FDIC’s authority.

Concerns regarding the Federal Reserve’s oversight of nonbank entities first began to surface when the Federal Reserve announced the results of its “stress test” for large nonbank entities, such as MetLife. After MetLife and others failed the “stress test,” it was apparent that the Federal Reserve was trying to fit square pegs into round holes. The Federal Reserve was employing the same metrics it had historically used to evaluate depository banks. Those metrics do not translate well to determine the viability and sustainability of large nonbank entities.

The proposed legislation is an extension of that square peg-round hole argument. It seeks to prevent the Federal Reserve from classifying nonbank entities as “too big to fail.” Trade groups argue that the designation of nonbank entities as systemically significant would subject such entities to such massive compliance costs, thereby forcing them out of business, or at the very least, further stifling an economic rebound.

Critics disagree. Critics of the bill argue that allowing nonbank entities to escape the Federal Reserve’s supervision may cause a financial panic. Thus, based on the opposing sentiments, it appears we have come full circle to damned if you do, or damned if you don’t.