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Tuesday, November 22, 2011

Financial Stability Oversight Council: A Framework to Mitigate Systemic Risk

Edward V. Murphy
Specialist in Financial Economics

Michael B. Bernier
Presidential Management Fellow

The Financial Stability Oversight Council (FSOC) was created by the Dodd-Frank Act (DFA) in 2010 as part of a comprehensive reform of banking and securities market regulators. The council is charged with monitoring systemic risk in the financial system and coordinating several federal financial regulators. Because the agency is new and because several potential risks remain to the financial system as a whole, the 112th Congress may wish to monitor the performance, rulemaking, and policy recommendations of the council.

This report describes the mission, membership, and scope of the FSOC. It provides an analysis of several major policy issues related to the FSOC that may come before the 112th Congress.

The DFA establishes a regulatory framework of which the FSOC is a consultative council. The new regulatory regime incorporates several policy tools to address systemic risk. The FSOC facilitates communication among financial regulators, collects and evaluates financial data to monitor systemic risk, and designates which financial institutions and financial market utilities will be subject to prudential regulation by the Federal Reserve. Upon a determination of a threat to financial stability, a covered non-bank financial institution in danger of failing may under certain conditions be resolved by the Federal Deposit Insurance Corporation (FDIC), rather than through the bankruptcy process. The FSOC may under certain circumstances set aside some financial regulations for consumers if the rules create systemic risk.

The DFA directed financial regulators to issue new regulations to mitigate systemic risk and required regulators to study other areas of concern. Examples include proposed or final rules for financial derivatives, clearinghouses, retained risk, and financial market utilities. The DFA mandates more than 80 studies and reports, including the potential use of contingent capital and reliance on the bankruptcy process as a resolution regime.

The Office of Financial Research (OFR), created to support the work of the FSOC, has contributed to the first annual report by the FSOC. The OFR assessed a number of areas of concern, including the European sovereign debt crisis, continuing weakness in housing markets, and potential illiquidity in municipal finance.

This report is intended to be used as a reference by congressional staff working on financial issues. The macroeconomic policy rationales for various financial crisis-related issues are summarized, and a glossary is provided to assist in understanding technical terms. This report is not intended to be read from cover to cover, but instead may be more useful as issues related to the FSOC arise.

Date of Report: November 15, 2011
Number of Pages: 53
Order Number: R42083
Price: $29.95

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