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What Is a Systemically Important Financial Institution?

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  • Written By: Jim B.
  • Edited By: Rachel Catherine Allen
  • Last Modified Date: 04 September 2016
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A systemically important financial institution is an institution such as a bank that is deemed so important that the economy would feel a significant impact if it should collapse. As a result, these institutions are generally regulated and overseen to prevent that sort of financial calamity from occurring. One general requirement of a systemically important financial institution is that it keeps enough capital in reserve to be available should a financial emergency strike. While regulation of these institutions is important, it is also important that they be able to conduct business without too many restraints so that they still have the leverage to stimulate the economy which they serve.

Within a global economy, it is unlikely for any financial event to occur in a vacuum. Something that affects a major bank in one country will likely cause a chain reaction that will impact all banks all over the world. For that reason, these financial institutions must be monitored to make sure they are not acting recklessly and putting the fortunes of many people in jeopardy. An institution that is particularly impactful is known as a systemically important financial institution.

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As the name implies, a systemically important financial institution is one that is of paramount importance to an entire economic system. This might be the case on a local level, such as a bank which serves a community. It can also occur on a worldwide level, since a handful of banks and other financial firms transact astronomical sums of money in the course of business every single day. The collapse of one of these institutions could lead to a ripple effect that would shake economies all over the world.

In the United States, the Dodd-Frank Act of Congress in 2010 was tailored specifically to make sure that a systemically important financial institution would not collapse and affect the economy as a whole. One of the key requirements is that the large banks and other firms categorized as systemically important keep a certain amount of capital in reserve at all times. Transactions of these firms are also scrutinized to prevent any sort of damaging activity.

The one caveat with regulating a systemically important financial institution in this manner is that is could cause an excess of caution. If these firms are restrained too much, the result could be a stagnant economy, with customers unable to borrow and small businesses unable to invest. Regulators must find a middle ground that allows these institutions to operate while still keeping close tabs on their business dealings.

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