Financial Stability Oversight Council

The Financial Stability Oversight Council (FSOC) is an interagency body created by the Dodd-Frank Act to monitor systemic financial risks and coordinate regulation. Chaired by the Treasury Secretary and including the heads of the Fed, SEC, CFTC, and other financial regulators, FSOC can identify threats to financial stability and designate non-bank financial institutions as systemically important, subject to additional regulation.

What FSOC does

FSOC’s mandate is to monitor systemic financial risks and coordinate regulation to promote financial stability. It does this by (1) conducting an annual review of the financial system, looking for risks that could threaten stability; (2) designating systemically important financial institutions (SIFIs) — non-bank companies whose failure would pose systemic risk — for additional regulation; and (3) recommending actions to regulators to address threats.

FSOC is notably not a regulator itself. It has no power to set rules, examine firms, or enforce laws. Its power is soft — it can recommend that the Fed regulate a company more closely, or it can recommend that Congress change a law. Nonetheless, FSOC designation as a SIFI has teeth, because designated companies must meet capital and liquidity standards set by the Fed and must undergo stress testing.

Systemic importance and SIFI designation

A systemically important financial institution is one whose failure or distress could trigger a cascade of failures elsewhere in the system. Typically, these are large, interconnected institutions. The classic SIFI is a large bank like JPMorgan or Bank of America — their failure could pull down other banks they do business with, trigger runs on other institutions, and freeze credit. But FSOC’s innovation was to apply SIFI designation to non-bank companies.

FSOC designated several firms as SIFIs in the years after Dodd-Frank: insurance company AIG (whose 2008 bailout was a template for systemic importance), Prudential, BlackRock, and others. These designations have been controversial. Prudential challenged its designation in court and won in 2015, arguing FSOC had not shown that Prudential’s failure would pose systemic risk. FSOC subsequently rescinded the Prudential designation and has been cautious about new designations.

Coordination among regulators

FSOC meets regularly to coordinate. The Treasury Secretary chairs; members include the Fed Chair, SEC Chair, CFTC Chair, Comptroller of the Currency, FDIC Chair, CFPB Director, and others. Each brings information about their jurisdiction’s risks. The Fed might report concerns about commercial real estate lending. The SEC might flag valuation risks in the credit market. FSOC synthesizes this information and tries to identify patterns — for example, if all regulators are seeing deteriorating commercial real estate loans, that is a systemic risk requiring coordinated response.

This coordination is valuable — finance is a network, and isolated regulatory fixes do not always solve network-level problems. However, FSOC also moves slowly, by committee, and sometimes the member agencies have conflicting interests (the SEC wants to regulate more, banks want less regulation, etc.).

Vulnerability assessments and recommendations

FSOC publishes an annual report assessing vulnerabilities in the financial system. These reports have highlighted concerns including commercial real estate overheating, cryptocurrency volatility, volatility in open-end mutual funds, and liquidity in corporate bond markets. Based on these assessments, FSOC recommends actions — sometimes to Congress (change a law), sometimes to individual regulators (adopt a rule), sometimes to the President (prepare for a crisis). Most of these recommendations are non-binding.

Criticisms and limits

Critics argue FSOC is too soft — it can recommend but not mandate changes. Others argue it is too political — the Treasury Secretary’s control means it can be influenced by the President’s party. Still others note that FSOC’s designation power, intended to catch the next big systemic risk, has largely been dormant since Prudential was dedesignated, suggesting FSOC may not be equipped to identify threats outside the traditional banking system.

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