By Dallin Merill, Director of MBS Policy of SFA
In December 2019, the Financial Stability Oversight Council issued its “Final Interpretive Guidance” regarding its authority to increase the Federal Reserve’s supervision of non-bank financial players and subject them to prudential standards. Non-banks include independent mortgage bankers, mortgage real estate investment trusts and non-bank investors in residential mortgage loans.
The guidance, which will go into effect Jan. 29, shows the council’s interest in the role of non-banks in mortgage lending and in formalizing how such entities will fall under its authority moving forward. The guidance aims to improve the council’s regulation process, based on prior criticism about its lack of structure and transparency.
SFA member Laurence E. Platt, partner at Mayer Brown LLP, has reviewed the updated guidance. The core points from Mr. Platt’s analysis include:
Adopting an entity-based approach
Notably, the new guidance replaces the former entity-based approach with an activities-based approach to address systemic risk to U.S. financial stability. Still, the council retains its ability to make entity-based determinations in situations where an activities-based approach would not be effective.
Coordination among regulators
Upon identifying potential risks, the council will work with federal and state financial regulatory agencies to ensure they take appropriate action. By collaborating with regulators first, the council should greatly reduce the need to intervene on its own.
However, if the council deems regulators’ actions to be inadequate, then it can make a public, non-binding formal recommendation to regulators after conducting a cost-benefit analysis to justify its determinations.
Dodd-Frank Act mandates
The Dodd-Frank Act of 2010 was enacted following the 2008 recession to ensure the federal government can manage risk among financial companies before it is too late. To make a determination about a non-bank financial company, the council will analyze 10 specific considerations specified under the act, as well as any other risk-related factors deemed appropriate.
Ultimately, the council’s concerns stem from a dramatic rise in the percentage of market share of residential mortgages handled by non-bank players over the last decade. The council’s 2019 Annual Report identifies the potential for material risk by virtue of the non-banks’ reliance on short-term funding, their abilities to perform during an economic downturn, and the potential for stress to spread among market participants.
Read Mr. Platt’s full legal update, “Could the U.S. Government’s Financial Stability Oversight Council Subject the Residential Mortgage Industry or Mortgage REITs to Supervision by the Federal Reserve and Prudential Standards?”
SFA will continue to assess the council’s efforts to mitigate risks to U.S. financial stability and monitor any efforts to increase oversight on non-bank financial companies.