Defining which financial firms beyond banks are systemically important is one of the biggest decisions still to be made by regulators under the Dodd-Frank Act.

The reform law gave a group of regulators, the Financial Stability Oversight Council, the task of identifying and responding to risks that could threaten the nation's financial health. It is this council that will decide which nonbanks are systemically important, and thus subject to loads of extra scrutiny.

Taking its first step, the council issued a preproposal, what's known as an "advance notice of proposed rulemaking." This is what regulators do when they either have no idea how to proceed or they can't agree on what to do.

In the case of tagging the systemically important, it's likely a bit of both.

The law lists 10 factors the council should weigh, from size to interconnectedness, but it also says the council may consider any other factor it fancies.

While most industry experts expect (or maybe they are simply hoping) the government will set its net narrowly, it's a good bet the Federal Deposit Insurance Corp. will once again be the odd man out and argue for a wider casting.

That's because Dodd-Frank handed the FDIC responsibility for unwinding any firm the government deems systemically important.

The agency is going to want a good look inside these companies before they get into trouble, and the only way to do that is to make sure any company able to unravel the financial system is designated as systemically important. The last thing the FDIC wants is a repeat of 2008: when the crisis hit, the two biggest nonbanks — Goldman Sachs and Morgan Stanley — made last-minute conversions to bank holding companies and gained all the protections the government was giving banks.

But the Federal Reserve Board is likely to take the opposite approach. Dodd-Frank put the Fed in charge of supervising these systemically significant nonbanks, and the central bank's staff is already stretched thin. The Fed is likely to argue that the Oversight Council should start small, pulling just a few firms into the systemically important fold. High on this shortlist are AIG and GE.

Getting any sort of consensus on the council will be tough. It will eventually have 10 voting members; nine heads of federal agencies and someone appointed by the president with expertise in insurance. But for now, just six of those 10 spots are filled with presidentially appointed people. Under the law, to label a firm systemically important requires a two-thirds vote — including the chairman's aye.

The chairman is Treasury Secretary Tim Geithner and his loyalties lie with the Fed where he spent much of his career, so the FDIC will face an uphill battle. Add to that the fact that nonbanks, from mutual funds to wealth managers to insurers, are all arguing against inclusion.

But the FDIC relishes its underdog role. Among the agency's shining moments was the lonely battle it waged — and won — against Basel II's plan to let large banks use internal models to set capital levels. The agency earned a lot of credibility in that debate at the Fed's expense.

"The FDIC will fight a rearguard action to make it as wide as possible," a former high-ranking FDIC official said. "And they will rush to get their oar in before Sheila leaves."

That's Sheila Bair, the FDIC's chairman, who has just six months left in her term. "The FDIC is going to push for a very broad scope and the FSOC will have to craft a compromise," the former FDIC official predicted.

A compromise might consist of a short list of officially important companies, and a longer, companion list of firms that will be subject to extra, just not excruciating, supervision.

It's not hard to see why nonbanks want to avoid this "important" designation. Systemically important firms — including all banking companies with assets of more than $50 billion — will be subject to "enhanced prudential standards," which means everything from higher capital and liquidity requirements to limits on activities, leverage and credit exposures. They will be stress-tested and forced to disclose more details about operations. They will have to write "living wills," another Dodd-Frank creation designed to force firms to explain how the government should unwind them if they fail.

And it's not just additional attention. Systemically important firms also will pick up the expenses run up by the Oversight Council and its Office of Financial Research.

Through 2012, those costs will be covered by the Fed. But after that, it will fall to the systemically important firms. How much that will be is unclear, but the council's initial budget for fiscal 2011 is $7 million. That assumes 17 employees and salaries of $4.4 million. But the minutes from the council's second meeting make it clear $7 million was just the starting point. "It is expected that there may be a need for additional staffing, which would require a supplemental budget request during 2011," the minutes state.

Congress is a wild card in this debate.

Bair has many friends on Capitol Hill, but the newly turned Republican House is vowing to eagle-eye implementation of Dodd-Frank and may argue that going narrow could reduce moral hazard. Some figure any firm officially labeled important to the financial system will be, by definition, too big to fail. The fewer of those firms, the better, they say.

Proponents of the narrow approach also argue that the government simply does not have the resources needed to apply such scrutiny to a large number of companies.

But those in favor of going wide say the market already knows which firms are "too big." In fact, the Stern School at New York University continually updates a list of the firms that it thinks are the most important.

Of Stern's current top 10, the first five are firms automatically covered by the law: Bank of America, Morgan Stanley, JPMorgan Chase, Goldman Sachs and Citigroup. The next five are not: Prudential Financial, Hartford Financial, SLM Corp., MetLife and Lincoln National.

Of course there are people who think the whole exercise is nonsense, that the government should not be fingering any firm as a threat to the financial system. But unless Congress changes the law, the council will have to forge ahead.

Comments on the preproposal, which posed 15 questions, many with multiple parts, were due in November. Dozens of firms sidestepped those questions and simply made the case for being excluded.

The council's next step will be to issue a formal proposal, upon which another round of public comments will be collected. Only then will a final rule be written, and the companies selected.

Once the regulators make up their collective mind, the Oversight Council will inform the chosen nonbanks, which will then have up to 30 days to request a hearing and an additional 30 days to submit material supporting their claim to be "unimportant." After a hearing, the council will have 60 days to make a final determination. At that point, any firm unhappy with the outcome can sue the government.

One note about the banking companies Dodd-Frank automatically included: The law does allow the council to raise the $50 billion threshold for some key components, including the application of the contingent capital requirement, living wills, credit exposure reporting, concentration limits, enhanced public disclosures and short-term debt limits.

If the council agrees to do that, many of the smaller banking companies will breathe a sigh of relief. Assuming they are still around. Today 36 banking companies meet that $50 billion-asset test, but the added oversight may lead some to sell. Possible case in point: Marshall & Ilsley's decision last week to sell itself to Bank of Montreal.

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