In 2009, heads of state gathered in shocked post-crisis fear and finalized unprecedented financial-system reforms sufficient, they prayed, to prevent a repeat catastrophe for decades to come.  One major pillar of the 2009 platform was systemic designation for banks, insurance companies, asset managers, finance companies, broker-dealers, private-equity firms, hedge funds, and pretty much any other entity that thought about money.  But, following the recent decision by the International Association of Insurance Supervisors, it’s now clear that it’s just a question of time before the only systemically-designated financial institutions are firms fool enough still to be banks.  Does this make sense anymore?

It does if banks have special privileges purchased at regulatory cost for monopolies on activities deemed critical to macroeconomic growth and financial stability.  If other entities perform these essential functions without the burden of new rules, then the rules that bind banks will only make markets still less stable.  The trade-off between special privileges for banks that are subject to tough rules because they are granted unique franchises to perform critical services has been foundational to both the business model and financial policy since the basic structure of central banking began to take shape in the 19th century.  Then, only companies chartered as “banks” were granted borrowing privileges.  The 1933 federal deposit-insurance system in the U.S. and those adopted since in other nations also grant this critical protection only to chartered entities, with parent companies now also forced to serve as sources of strength for their subsidiary insured depositories.  In short, live by the government, die by the government’s regulated hand or so this privileges-offset-by-rules regime is supposed to work.

The post-2008 framework recognized that this trade-off broke down ahead of the crisis because banks didn’t die when they should have and non-banks looked a lot like banks, only happier in the absence of prudential regulation.  During the crisis, all too many non-banks were also granted direct or indirect bail-outs akin to or even bigger than those given to banks.  The FDIC for example guaranteed not only insured deposits or even just debt from banks and BHCs, but also that across the spectrum of companies that had wiggled their way into bank ownership as the barriers fell between banking and commerce.  The Treasury backed a mid-size money-market fund, investment banks scrambled to become BHCs to get under the Fed’s presumed too-big-to-fail umbrella, and even finance companies sought similar shelter.  Failures backed by systemic assistance of course encompassed not just banks, but also GSEs and a very large insurer, AIG.  The only non-bank that died by its own hand – Lehman – seemed to prove the point that large non-banks warrant systemic regulation. 

Much has been done in the U.S., if not elsewhere, to end the TBTF assumptions on which both bank and non-bank regulation rested after 2008.  The orderly-liquidation framework and all its relevant big-bank rules along with greater understanding of the importance of the Bankruptcy Code have seen to that.  However, even though non-bank risks come in different ways than those that can topple a bank, only very big banks are very likely not to need a bail-out under acute stress because only these banks are under all of these post-crisis rules.  After all, they are the only ones forced to file living wills, are subjected to TLAC buffers, compelled to comply with capital surcharges, and are otherwise made as bullet-proof as regulators can hope. 

Despite all this hard experience, political opposition first from asset managers and then insurers has doomed SIFI designations, with global regulators instead now espousing the activity-and-practice approach outlined in the IAIS consultation.  But, even as the knife goes through SIFI designation, it’s increasingly improbable that anything like activity-and-practice regulation will ever be implemented – IAIS makes it very, very clear that it’s just doodling here and nothing on which it asks for comment should be taken as anything other than just a thought or two. 

Perhaps the most surprising aspect of this hesitant approach to systemic activity-based regulation for insurers is that IAIS doubts all of the indicators for systemic risk on which the GSIB framework is founded.  And, indeed, global bank regulators aren’t all that sure about their own GSIB requirements – the Basel Committee is also thinking about a new GSIB-designation methodology.  The U.S. Treasury has made its antipathy to SIFI designation more than clear in its recent reform reports

Perhaps global regulators will abandon GSIB-designation criteria and the Fed will follow suit.  An activity-or-practice approach adopted across the financial industry makes firm-specific designations at best unnecessary.   However, so wholesale a shift from the Fed or other U.S. financial regulators is at best far from certain.  What seems more likely is that, notwithstanding Basel’s pending inquiry, big banks will stay GSIBs, activity-and-practice regulation for non-banks will falter, and nothing much will happen to non-banks.

Nothing that is but more and more direct and indirect access to the privileges for which banks now pay a handsome regulatory price.  The U.S. is for example considering allowing far greater integration of banking and commerce under the fintech mantle without deciding just how the benefits of bank charters flow through – if at all – to the shareholders of non-bank parents.  Even if bank charters are conditioned on bank-like rules, so what?  As I told the American Banker, what platform company could be rash enough to take on regulatory burden for privileges it doesn’t think it needs?

Many non-banks and most importantly those with significant “platform” capacity such as Amazon and Apple are already taking on key bank payment and intermediation roles.  So far, it’s small, but so far isn’t very far given the potential in these platform companies and the near-term potential for consumers – not banks – to own critical personal financial information.  Recall that Amazon’s “Prime” subscription service went from an employee idea in a suggestion box to Jeff Bezos’ desk to market in just a bit more than three months and see what a non-bank can do when it comes to product innovation.

The result of asymmetric regulation will be one set of big regulated companies, another set of even bigger unregulated companies, and a very porous barrier between those with rights to access taxpayer-provided privileges.  Indeed, even if policy were to set the barrier more firmly – and there’s little chance of that at present – retail consumers and wholesale counterparties are still convinced that someone somewhere will bail them out.  How could Bitcoin be what it is now without sweeping TBTF expectations?

We are thus rapidly evolving to the worst possible post-crisis financial framework:  hidebound big banks out-maneuvered by adroit, unregulated competitors gobbling up customers who are convinced that all the protections attendant to doing business with a bank apply to a non-bank.  Uh-oh.