CFS Senior Fellow Proposes Framework for Quantifying SIFI Complexity (with Lofchie Comment)

In an article titled "The Intrafirm Complexity of Systemically Important Financial Institutions," Center for Financial Stability ("CFS") senior fellow and American University Professor Robin Lumsdaine and her co-authors propose a framework for assessing the organizational complexity of individual financial institutions via network-based metrics.

Professor Lumsdaine states that to date, the designation of systemically important financial institutions ("SIFIs") is the result of an evaluation of the size of an institution combined with an assessment of its level of interconnectedness with other firms. However, she argues, in addition to size and interconnectedness, the Financial Stability Board's definition of a SIFI includes a third attribute: institutional complexity.

According to the article, little has been done to quantify the complexity of large financial institutions. In trying to develop the metrics concerning the complexity of these institutions, Professor Lumsdaine and her co-authors use information on the structure of firms' control hierarchy to assess oversight challenges that a complex structure may pose, not just for a firm's senior management, but also to supervisors. For the set of institutions examined in the paper, the findings include:

  • firms' complexity and size are not synonymous;
  • size-based thresholds for SIFI determination are unsatisfactory;
  • generally speaking, firms have reduced their complexity between 2011 and 2013;
  • there is little difference between SIFI and non-SIFI banks in their level of complexity, despite very different business models; and
  • in contrast, insurance companies are relatively more complex, despite being smaller in size, having fewer subsidiaries, and being less geographically or industry-diverse than the banks.

Lofchie Comment: The authority of the FSOC to designate a financial institution as "systemically significant" on the basis of standards that are entirely ambiguous, including, "any other risk-related factors that the Council deems appropriate" (See Section 113 of Dodd-Frank,) is questionable. The regulation of markets under the authority of a statute or a rule that contains no clear standards is simply not the way a society governed by law should work. Though unlikely, one day the SIFI designation may be transformed into something that resembles the rule of law. Until then, it is a positive sign that academics are making efforts to quantify factors that might reasonably result in a SIFI designation.

See: Brief of The Intrafirm Complexity of Systemically Important Financial Institutions; Full paper by Robin L. Lumsdaine, Daniel N. Rockmore, Nick Foti, Gregory Leibon, and J. Doyne Farmer.

Body of Law: