The House Financial Services Committee has approved legislation aimed at preventing the failure of large financial institutions from turning into a systemwide crisis.

H.R. 3996, the Financial Stability Improvement Act, was approved by a party-line vote of 31-27. The legislation would create an inter-agency Financial Stability Oversight Council that would identify and monitor financial firms and activities that could potentially undermine the nation’s financial stability. Once identified, these firms and activities would be subject to stricter oversight, standards and regulation.

Accounting organizations such as the American Institute of CPAs were able to weaken an amendment that would have allowed the oversight council to rewrite or suspend accounting rules if they had the potential to threaten the stability of the financial system. Instead, the council would merely be able to review and submit comments to the Securities and Exchange Commission and any standard-setting body on accounting principles, standards and procedures. However, the SEC and the Financial Accounting Standards Board would be free to accept or reject the suggestions.

The Financial Stability Oversight Council would be tasked with monitoring the marketplace to identify potential threats to the stability of the financial system. It would be able to subject financial companies and activities that pose a threat to financial stability to much stricter standards and regulation, including higher capital requirements for companies, leverage limits and limits on concentrations of risk.

The Federal Reserve would serve as the council’s agent for regulating systemically risky firms and activities. The legislation also enhances the authority of the Government Accountability Office to examine the Federal Reserve Board of Governors and the Federal Reserve Banks to provide greater transparency in Fed facilities and actions.

The bill would also remove Gramm-Leach-Bliley Act restraints on the consolidated supervision of large financial companies by the Federal Reserve, and would provide authority to the Fed and other federal financial agencies to regulate for financial stability purposes and quickly address potential problems.

In addition, the bill would establish an orderly process for dismantling any large failing financial institution in a way that minimizes the impact to the financial system and protects taxpayers. If a large institution fails, the bill would hold the financial industry and shareholders responsible for the cost of the company’s orderly wind-down, not taxpayers.

The bill would also place additional safeguards on industrial loan corporations and other non-bank depository institutions, bringing them under a consolidated supervisory framework.

Financial services industry representatives reacted negatively to the bill. “While the goal of the committee is well-intentioned, the bill will increase risk and inject more uncertainty into the financial markets — the exact opposite of the direction we need to move,” said Scott Talbott, senior vice president of government affairs at the Financial Services Roundtable, in a statement.

The bill would consolidate the Office of Thrift Supervision with the main federal bank regulator, the Office of the Comptroller of the Currency, but would preserve the thrift charter for thrifts dedicated to mortgage lending and would subject thrift holding companies to supervision by the Fed.

New rules woud require creditors to retain at least 5 percent of the credit risk associated with any loans they transfer, sell or securitize. In addition, the Federal Deposit Insurance Corp. would be able to extend emergency financial stabilization loan guarantees to solvent banks and predominantly financial companies only in a liquidity crisis. The facility would be funded by fees paid by financial companies that request such guarantees.

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