(Adds more details from report, background)
By Pete Schroeder
WASHINGTON, Nov 17 (Reuters) - The U.S. Treasury Department said on Friday regulators should closely monitor risk across the whole financial system, rather than singling out large non-bank financial firms for tougher scrutiny.
The eagerly awaited policy recommendation marks another win for the financial industry, which has been lobbying to change the current process of designating individual firms as "systemically risky," which they say is opaque and arbitrary.
Its findings mark a clear shift from the approach of former President Barack Obama's administration, under which regulators focused on targeting individual, large companies for tougher oversight including higher capital requirements.
In the 68-page report issued on Friday, the Treasury urged the Financial Stability Oversight Council (FSOC) to reduce its reliance on identifying certain firms as "systemically important financial institutions" (SIFI), a label that carries with it more rigorous oversight under the Federal Reserve.
Rather, the Treasury called on the panel, which was created after the 2007-2009 financial crisis, to make its first priority monitoring the financial system as a whole rather than singling out companies. The panel should rely on primary regulators as the first line of defense, and only place a SIFI label on a company as a last resort, the Treasury recommended.
It appears likely the changes will be adopted by the panel, which is chaired by Treasury Secretary Steven Mnuchin and consists of a majority of President Donald Trump appointees. Mnuchin is expected to make consideration of those changes a high priority, according to a senior administration official.
Most of the Treasury's recommendations are aimed at how the FSOC regulates non-bank financial companies, whereby regulators exercise significant discretion in singling out companies for tougher rules.
The Treasury described the SIFI designation as a "blunt instrument" in its report, arguing instead that it should fall primarily to individual regulators to monitor risks within their jurisdiction, while the FSOC focuses on broad challenges overall.
The Trump administration has already taken steps to reduce the FSOC’s footprint. In September, the panel voted to remove the SIFI label from American International Group, leaving Prudential Financial Inc as the lone non-bank SIFI still facing tougher scrutiny. That insurance company is expected to make the case for removing the label when it receives its annual review from the FSOC in the coming months.
Insurance company MetLife originally received a SIFI label but successfully challenged it in federal court. An appeal by the government had been stayed while the Treasury's FSOC conducted its review. The report does not weigh in on whether the government should drop its appeal.
Under current law, all banks with over $50 billion in assets are automatically considered SIFIs, although there is legislation pending in the U.S. Congress to raise that threshold to $250 billion.
The report also recommends the FSOC boost its transparency across a range of its operations. That includes establishing a clear "off-ramp" for firms carrying a SIFI label, where regulators more clearly lay out what steps should be taken to escape that designation. It also called for regulators to more rigorously consider the costs of applying stricter rules, and whether it would outweigh the benefits granted to the system.
The Treasury’s findings are a result of an executive order signed by Trump in April. (Editing by Bernadette Baum and Susan Thomas)