Earlier today, the Financial Stability Board (the “FSB”) approved and the Basel Committee on Banking Supervision (the “Basel Committee”) published a new set of regulatory guidelines for domestically systemically important banks (“D-SIBs”).1 This framework follows the publication almost a year ago of a process for identifying and supervising globally systemically important banks (“G-SIBs”).2 Today’s document similarly provides for enhanced regulation of D-SIBs, although it appears to be somewhat less stringent and prescriptive than that for G-SIBs. For example, the D-SIB Framework calls for an additional loss absorbency requirement but does not offer any specifics as the G-SIB Framework does.

A D-SIB is a banking organization whose failure or impairment would have external effects that would damage the real economy. The purpose of the D-SIB Framework is to limit those effects, as well as the likelihood of failure or impairment, through better supervision, risk management, and, if necessary, higher capital requirements.

To these ends, the D-SIB Framework sets forth twelve principles for supervision (which are included in the appendix hereto). Seven of the twelve discuss the methods for determining whether a bank is a D-SIB. The process outlined provides for broad national discretion. Principle 5 identifies four bank-specific factors that a regulator should evaluate: size, interconnectedness, substitutability and the financial institution infrastructure, and complexity (including those that may arise from cross-border activity). The G-SIB Framework includes these factors as well.

Five of the twelve address a higher loss absorbency (“HLA”) requirement that may be appropriate for a D-SIB. The HLA requirement is modeled on a similar requirement for G-SIBs, but the D-SIB Framework does not provide a scoring system or specific buckets of additional capital requirements. As with the assessment methodology principles, the HLA principles allow for considerable national discretion. Nevertheless, three important points emerge from these principles. First, an HLA requirement should be tied to the factors assessed under Principle 5. Second, the imposition of such requirements may involve significant cross-border communication and coordination issues. The home regulator may impose an HLA requirement at the parent and/or consolidated level, while a host regulator may impose one at the relevant subsidiary level. Indeed, a subsidiary of a bank already regulated in its home country as a G-SIB could be subject to a D-SIB HLA requirement in a host country. Third, a D-SIB must satisfy any HLA requirement with common equity tier 1 capital (as must a G-SIB).

The immediate question is which banks may be captured under the D-SIB Framework, and the short answer is that we do not know. Readers will recall that shortly after the publication last year of the G-SIB Framework, the FSB identified 29 G-SIBs that would be subject to HLA requirements ranging from 1.0% to 2.5%. By contrast, most of the risk of a D-SIB is national, and the home regulator is expected to have the expertise to designate such banks.

For U.S. banking organizations, a possible universe of D-SIBs is those organizations with more than $50 billion in consolidated assets – for which the Dodd-Frank Act mandates enhanced regulation – but that have not been designated as G-SIBs. This method could result in approximately 20 D-SIBs among U.S. banking organizations.3

We are continuing to analyse this framework and other approaches to systemic risk regulation and expect to report further on them in the near future.

Click here to view the Appendix.