The FSB have named 30 banks as being “too big to fail”(TBTF) on a global basis. How were they selected? And what risks, beyond mere size, do they pose?

You might have expected the nomination of G-SIBs to be based upon something simple, like size, asset value, capitalisation or similar. But no. They are, after all, presented in different “risk buckets.”

The FSB hasn’t been particularly transparent in describing the algorithms used to build the list. Jamie Dimon of JPMC has been vocal in his April 2015 letter to shareholders in complaining of this lack of transparency and the consequent presentation of JPMC in the highest risk bucket as the largest potential threat to the global financial system, irrespective of the risk measures adopted by the bank. The effect of this is to require JPMC to set aside the greatest quantum of additional capital (TLAC), and that they are already penalised by the US financial regulatory regime, which requires US banks to reserve more capital (and liquidity) than their international counterparts, operating under their own national supervisors.

This lack of FSB transparency is reduced by a publication from the Office of Financial Research (OFR) in August 2015 (http://financialresearch.gov/briefs/files/OFRbr-2015-07_A-Comparison-of-US-and-International-Global-Systemically-Important-Banks.pdf) . The OFR is a department of the US Government Treasury, designed to “shine a light” on the financial markets, to the benefit of US politicians and citizens, who need interpretation of complex and arcane financial data. This paper answers Dimon’s questions, using the methodology and algorithms applied by the FSB in evaluating the TBTF risk, of 75 banks, from which the 30 G-SIBs are nominated.

The FSB methodology for G-SIB designation uses 12 indicators of systemic importance, grouped into five categories:

1. Size, measured through total exposures.
2. Interconnectedness, measured through a bank’s intra-financial system assets, intra-financial system liabilities, and total securities outstanding.
3. Substitutability, or the extent to which a bank provides important financial infrastructure that would be difficult to replace if the bank were to fail. It is measured through payments activity, assets under custody, and underwriting activity.
4. Complexity, measured through a bank’s over-the-counter derivatives activity, trading and available-for-sale assets, and holdings of less liquid assets.
5. Cross-jurisdictional activity, measured through a bank’s foreign claims and total cross-jurisdictional liabilities.

If the purpose of this paper is to ask why there are so many US banks designated, then the answers to this are to be found in the tables set out for each of the 12 indicators. But why for example are the 4 large Chinese banks, which all appear in the Top 10 by asset value, rated so lowly for risk purposes by comparison?

The first level answer is simple. The US economy is the largest active trading economy in the world, even if other markets lend and borrow (and create greater exposures) than the US banks.

The second is more interesting. It is in the areas of interconnectedness, substitutability and complexity that the US banks are marked up (or is it down?) on. If you work through this, then it is the asset servicing and custody banks which attract attention here. So much cash is tied up in the securities lending and repo (a $15 trillion) markets, that their daily settlement presents potentially a huge systemic risk. Small wonder that the Fed has been so vociferous of late in the need for reform of the tri-party repo market, with specific attention being paid to JPMC and BONY Mellon, as the clearing agents and Citi and State Street as the two largest users of this market.

So, in working out which of the world’s banks need to protect most expensively against systemic failure, then the FSB are betting that the greater systemic risk is some form of failure in securities settlement in the US, rather than, say, a large change in the oil price, continued uncertainty in Chines markets, or the volatility of one of the world’s major currencies. You might therefore bet that the asset management industry is next on the regulatory list for reform.