i. Is MetLife a potential danger to the financial system in the same way as, say, a large bank? Is GEC?
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Insurance isn’t as risky as banking because it doesn’t have the maturity mismatch between its assets and liabilities. However, insurance companies do hold assets for liquidity that are sold at fire sale prices in a crisis, which can impede banks who are trying to do the same thing. Insurers tend to hold similar portfolios, making them vulnerable to contagion, and are large so can have big impacts on the markets. Reinsurers are also connected, which can have ramifications for the insurers themselves. State regulators provide checks on insurance companies to make sure they collect adequate premiums and hold sufficient reserves, but the failure of a large company can stress state insurance reserve funds. Most insurers are undercapitalized as well - Metlife has an equity ratio of 5.6%.Financial distress of nonbanks can be transmitted to the banking sector through “counterparty relationships, disruptions in funding markets, and knock-off effects of asset fire sales”. Counterparty failures, liquidity shortages and losses due to “fire sales” occur routinely in markets, but don’t create systemic risk like the banks do.Finance companies and life insurance companies don’t face the same level of maturity mismatch that banks do, and face different problems and solutions in terms of credit, interest rate, market, and other risks. They are also more specialized so probably less risky.ii. Was the Fed already empowered to help nonbanks in a crisis? How?It is the lender of last resort for the economy as a whole - can pressure banks to resume lending or promise to provide liquidity. iii. Is MetLife undercapitalized at an equity ratio of 5.6%? Is GEC ‘too risky’? Who is the best judge? The market is the best judge - if customers think that Metlife if undercapitalized they will go elsewhere for insurance, and if they think GEC is too risky they’ll demand more for their deposits or go elsewhere. Life insurance companies’ liabilities can’t be withdrawn on demand. v. What, again, is the reason for prudential (risk) regulation of banks? Does this apply to nonbanks? So why the new regulations?Prudential regulation of banks is done because of the maturity mismatch between assets and liabilities, and because banks expose the government to riskthrough deposit insurance. Insurers don't benefit from a taxpayer-backed safety net, as banks do. Life insurers' separate accounts -- which hold the premiums and investment returns
of insured individuals -- shouldn't be treated like bank deposits, because they can't be withdrawn on demand.The regulations are likely in response to political pressure from concerned consumer activist groups and from banks who face competition from non banks.
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