Shadow Banking – Digital Finance Analytics (DFA) Blog

Global Shadow Banking Sees Heightened Regulatory Scrutiny

Continued increases in shadow-banking regulation should be a net positive for system-wide stability and liquidity if maintained over the medium term, says Fitch Ratings.

Overall shadow-banking asset levels have remained manageable. However, more rapid growth in certain regions and activities is expected to attract additional regulatory scrutiny, given the potential indirect effects of market interconnectedness and/or asset price volatility on the overall financial system.

Shadow-banking assets were $45 trillion, as of YE16, or 13.2% of total global financial assets, according to the Financial Stability Board (FSB). This marked an increase of 7.6% over the previous year. In the US, shadow-banking assets remained relatively stable at $14.1 trillion, as of YE16, or 31.6% of total global shadow-banking assets. Conversely, China’s shadow-banking assets increased to $7 trillion, rising from 1.4% of total global shadow-banking assets in 2010 to 15.5% at YE16, a 40.1% CAGR on an exchange rate-adjusted basis, according the to the FSB. Euroarea shadow-banking assets were $10.1 trillion, as of YE16, falling to 22.4% of total global shadow-banking assets from 27.3% in 2010.

Of the $45 trillion of global shadow-banking assets at YE16, 72% were held by collective investment vehicles, such as open-end fixed income, money market, and credit hedge funds, which largely drove asset growth for the last five years. The inherent redemption risk of these vehicles could pressure asset prices in the event of runs, particularly if material leverage is employed.

Globally, banks continue to have modest direct exposure to Other Financial Intermediaries (OFIs), the FSB’s broad measure of shadow-banking activity, both in lending and borrowing. At YE16, aggregate funding and credit interconnectedness between banks and OFIs approximated pre-crisis (2003-2006) levels after several years of decline. Banks’ claims on OFI assets were $6.3 trillion, or 5.6% of total bank assets, while funding from OFIs was $5.9 trillion, or 5.4% of total funding. That said, given the level of broader interconnectedness between banks and shadow-bank participants, and the potential for regulatory arbitrage to be employed by market participants, global regulatory scrutiny is expected to continue.

China’s regulators have responded to rapid shadow-banking growth with increased oversight, particularly on wealth management and trust products, the origination, of which, have begun to level off after years of growth. The increased regulation is aimed at improved transparency and disclosure in order to reduce contagion risks within the system, rather than reducing the scale of shadow banking, which could disrupt the stability and liquidity of the financial system. We believe the Chinese government will continue to focus on regulation as long as it does not materially hamper GDP and economic growth.

China’s shadow-banking sector is more systemic and complex than other more developed markets, with the extent of interconnectivity and risk, creating significant potential risk for Chinese banks. Unlike the US, where non-banks tend to be the dominant shadow-banking participants, banks are a key component in China’s shadow-banking ecosystem. While the shadow-banking products in China may be less complex than in the US, the evolving implicit/explicit guarantees in China make it more difficult to pinpoint who bears the ultimate investment risk. Smaller Chinese banks, relying on the interbank market and shadow banking for liquidity, may see rising funding costs as a result of increased regulation, while larger banks with stronger deposit franchises may be relatively better insulated than smaller, less capitalized peers.

Shadow Banking Risks Reduced – FSB

The FSB defines shadow banking as “credit intermediation involving entities (fully or partially) outside the regular banking system.”

The aspects of the shadow banking activities generally considered to have made the financial system most vulnerable and that contributed to the financial crisis have declined significantly and are generally no longer considered to pose financial stability risks. This decline is due in part to regulatory reforms, changing risk appetite, and rejection of particular products and funding models. Other elements of shadow banking, such as MMFs and repos, also experienced declines from previously elevated levels.

The FSB has been publishing the results from its annual global shadow banking monitoring exercise since 2011. The FSB published the results from its most recent 2016 monitoring exercise in May. The results found that activity-based, narrow measure of shadow banking was $34 trillion in 2015, increasing by 3.2% compared to the prior year, and equivalent to 13% of total financial system assets and 70% of GDP of these jurisdictions. The narrow measure figure represents shadow banking risks before policy measures are applied.

In response to a request from the G20, the Financial Stability Board (FSB) today published an assessment of the evolution of shadow banking activities and risks since the global financial crisis, and the adequacy of post-crisis policies and monitoring to address these risks.

This assessment highlights that the aspects of shadow banking considered to have contributed to the global financial crisis have declined significantly and generally no longer pose financial stability risks.

The assessment also describes how, since the financial crisis, policies have been introduced to address financial stability risks from shadow banking:

Authorities are establishing system-wide oversight and monitoring frameworks to assess the financial stability risks from shadow banking, so that appropriate policy measures can be taken. This includes annual monitoring exercises by the FSB since 2011 to assess global trends and risks in the shadow banking system.

Authorities have taken steps to address banks’ involvement in shadow banking, including through enhanced consolidation rules for off-balance sheet entities and strengthened bank prudential rules.

Authorities have acted to reduce liquidity and maturity mismatches, and also leverage in the shadow banking system, including through regulatory reforms of money market funds and recommendations on securities financing transactions.

National and regional reforms have been undertaken to address incentive problems and opaqueness associated with securitisation, alongside increases in capitalisation of banks’ securitisation related exposures.

However, a rise in assets held in certain investment funds has increased the risks from liquidity transformation. These developments underscore the importance of effective operationalisation and implementation of the FSB’s January 2017 policy recommendations to address structural vulnerabilities from asset management activities.

At present, the FSB has not identified other new financial stability risks from shadow banking that would warrant additional regulatory action at the global level. However, since shadow banking evolves over time, authorities should continue to monitor vigilantly and address promptly emerging financial stability risks.

To these ends FSB member authorities have agreed the following recommendations:

Enhance system-wide oversight of shadow banking and policy responses to address the identified risks by: (i) establishing a systematic process for assessing financial stability risks from shadow banking, and ensuring that any entities or activities that could pose material financial stability risks are brought within the regulatory perimeter; (ii) addressing identified gaps in risk-related data; and (iii) removing impediments to cooperation and information-sharing between authorities.
Strengthen the monitoring of shadow banking activities and data collection. The FSB will assess the data availability and make improvements to its annual monitoring exercise as appropriate in 2018.
Complete the remaining policy development at the international level and implement the agreed policy recommendations to reduce risks and arbitrage opportunities across jurisdictions and sectors. In this regard, it is important that: (i) the Basel Committee on Banking Supervision completes its guidelines on step-in risk; (ii) the International Organization of Securities Commissions effectively operationalises the FSB recommendations to address structural vulnerabilities from asset management activities in line with the agreed timeline; and (iii) national/regional authorities implement agreed policy recommendations in a timely and consistent manner.

Mark Carney, Chair of the FSB, said “This assessment confirms the extent of the transformation of shadow banking into resilient market-based finance. It concludes that the agreed policies, once fully and effectively implemented, will be adequate to address existing risks. Of course, since shadow banking activities will inevitably evolve over time, FSB member authorities will strengthen surveillance to support ongoing risk assessments and guide any future regulatory response”.

Klaas Knot, Chair of the FSB Standing Committee on Assessment of Vulnerabilities and President of De Nederlandsche Bank, said “While we have achieved a great deal, authorities need to remain alert to risks from shadow banking. It is important for authorities to continue to improve data availability, risk analysis and information sharing so as to be able to identify new sources of systemic vulnerabilities in a timely manner”.

Norman Chan, Chair of the FSB Standing Committee on Supervisory and Regulatory Cooperation and Chief Executive of the Hong Kong Monetary Authority said “While the growth in asset management activities provides new sources of credit and investment to our financial system, it reinforces the need to effectively operationalise and implement the FSB’s asset management recommendations to address structural vulnerabilities from such activities”.

The FSB has been established to coordinate at the international level the work of national financial authorities and international standard setting bodies and to develop and promote the implementation of effective regulatory, supervisory and other financial sector policies in the interest of financial stability. It brings together national authorities responsible for financial stability in 24 countries and jurisdictions, international financial institutions, sector-specific international groupings of regulators and supervisors, and committees of central bank experts. Through its six Regional Consultative Groups, the FSB conducts outreach with and receives input from an additional approximately 65 jurisdictions.

Global Shadow Banking Worth $34 trillion in 2015, Up 3.2%

The Financial Stability Board (FSB) today published the Global Shadow Banking Monitoring Report 2016. The report presents the results of the FSB’s sixth annual monitoring exercise to assess global trends and risks in the shadow banking system, reflecting data up to the end of 2015. It covers 28 jurisdictions, including Belgium and the Cayman Islands for the first time. These jurisdictions together account for about 80% of global GDP.

The “shadow banking system” can broadly be described as “credit intermediation involving entities and activities (fully or partially) outside the regular banking system” or non-bank credit intermediation in short. Such intermediation, appropriately conducted, provides a valuable alternative to bank funding that supports real economic activity. But experience from the crisis demonstrates the capacity for some non-bank entities and transactions to operate on a large scale in ways that create bank-like risks to financial stability (longer-term credit extension based on short-term funding and leverage). Such risk creation may take place at an entity level but it can also form part of a chain of transactions, in which leverage and maturity transformation occur in stages, and in ways that create multiple forms of feedback into the regular banking system.

As part of the FSB’s strategy to address financial stability concerns associated with shadow banking and transform it into resilient market-based finance, the FSB has been conducting an annual system-wide monitoring to track developments in the shadow banking system. The monitoring exercise adopts the activity-based “economic function” approach where authorities narrow the focus to those parts of the non-bank financial sector where financial stability risks from shadow banking (such as maturity/liquidity mismatches and leverage) may arise and may need appropriate policy responses to mitigate these risks. While further refinements are needed going forward, the 2016 exercise deepened the analysis of this activity-based narrow measure of shadow banking by looking at its components and the potential risks in more detail.

The main findings from the 2016 exercise are as follows:

The activity-based, narrow measure of shadow banking was $34 trillion in 2015, increasing by 3.2% compared to the prior year, and equivalent to 13% of total financial system assets and 70% of GDP of these jurisdictions.

Credit intermediation associated with collective investment vehicles (CIVs) comprised 65% of the narrow measure of shadow banking and has grown by around 10% on average over the past four years. The considerable growth of CIVs in recent years has been accompanied by liquidity and maturity transformation, and in the case of jurisdictions that reported hedge funds, relatively high level of leverage.

Non-bank financial entities engaging in loan provision that are dependent on short-term funding or secured funding of client assets, such as finance companies, represent 8% of the narrow measure, and grew by 2.5% in 2015. In at least some jurisdictions, finance companies tended to have relatively high leverage and maturity transformation, which makes them relatively more susceptible to rollover risk during periods of market stress.

In 2015, the wider aggregate comprising “Other Financial Intermediaries” (OFIs) in 21 jurisdictions and the euro area grew to $92 trillion, from $89 trillion in 2014. OFIs grew quicker than GDP in most jurisdictions, particularly in emerging market economies.

The 2016 exercise also collected new data to measure interconnectedness among the bank and the non-bank financial sectors and to assess the trends of short-term wholesale funding, including repurchase agreements (repos). While the data availability needs to be improved, the data collected suggested that on an aggregated basis, both banks’ credit exposures to and funding from OFIs have continued to decline in 2015, although they remain above the levels before the 2007-09 financial crisis.

Australia is in the middle of the pack, in terms of percent of total financial assets. The US had the largest shadow banking sector, with $13.8 trillion in 2015, representing 40% of the total shadow banking sector reported by the 27 jurisdictions. The Cayman Islands reported the second largest shadow banking sector, amounting to $4.3 trillion, followed by Japan ($3.2 trillion), and Ireland ($2.2 trillion).

Compared to 2011, the US share of the total shadow banking sector for 27 jurisdictions declined from 48% to 40% according to the narrow measure, whereas the Cayman Islands’ share increased from 8% to 13%. Combined together, the US, the UK, and participating euro area jurisdictions represented 65% of total global shadow banking at end-2015, compared to 73% in 2011.109 Combined, participating euro area jurisdictions represented 20% of the global narrow measure, amounting to $6.8 trillion in 2015.

Loans extended by the OFI sector have been growing in 14 jurisdictions and the euro area since 2011. In some jurisdictions the growth in OFI loans since 2011 has been substantial, increasing at an annual rate of 10% or more in Australia, China, Germany, Indonesia, Korea, and South Africa, with China reporting the highest increase of 35%.

In Australia, banks have half of total national financial assets.

Mark Carney, Chair of the FSB, said “Market-based finance provides important diversification of the funding sources which support the real economy. The enhanced and coordinated system-wide monitoring by authorities continues to improve our understanding of non-bank financial activities and risks to the financial system. This helps to inform our judgement on appropriate policy responses as we transform shadow banking into resilient market-based finance”.

Klaas Knot, Chair of the FSB Standing Committee on Assessment of Vulnerabilities and President of De Nederlandsche Bank, said “The 2016 monitoring exercise has made progress by broadening its scope and deepening the analysis of associated financial stability risks. As shadow banking by its nature continuously evolves and adapts to a new environment, it is important for authorities to continue to improve data availability and risk analysis so as to be able to identify new sources of systemic vulnerabilities in a timely manner”.

The FSB Chair’s letter to the G20 Finance Ministers and Central Bank Governors ahead of their Baden-Baden meeting noted that in completing the work under the Shadow Banking Roadmap, the FSB has not identified new shadow banking risks that currently require additional regulatory action at global level. However, given that new forms of shadow banking activities are certain to develop in the future, FSB member authorities must maintain and continue to invest in an effective and ongoing programme of surveillance, data sharing and analysis so as to support judgements on any required regulatory response in the future.

Shadow banking and where it came from

From The Conversation.

The term “shadow banking” often has connotations of dodgy lending and borrowing practices, out of reach of regulators. And while its use may contribute to risk, in reality shadow banking does serve a purpose in our economy, one that is increasingly connected to our day-to-day lives.

Shadow banking affects not only the property market, but also superannuation, central banking policy and, increasingly, fiscal and social policy. It refers to the non-bank financial intermediaries that supply services similar to commercial banks.

This system provides funding for credit, by converting risky and long-term assets that can’t be sold quickly or easily (like mortgages) into a money-like, short-term debt (like mortgage-backed securities).

Shadow banking is not a bank in the sense that we know it but more a strategy or accounting technique. A range of institutions deploy these strategies including superannuation funds, insurance companies and local governments. Asset managers, like Macquarie Group in Australia and BlackRock in the United States, also employ these techniques.

In short, shadow banking provides institutions the means to create accounting entities to isolate risks, transfer profits, avoid regulation and increase the range of money-like financial products available for investment.

Where shadow banking came from

There are both supply and demand reasons for the emergence of the shadow banking system. Shadow banking has emerged as a means for financial firms to bypass regulation (for example by using tax havens) and increase opportunities for financial innovation and speculative activity.

Banks have an incentive to lower the number of risky assets on their balance sheets, in order to reduce the amount of capital they need to hold to cover these risks. Because of this the banks create off-balance sheet entities (assets that use shadow banking).

Shadow banking also offers a means for investors to access different forms of money across the financial system. Institutional investors trade in volume, and cannot physically “handle billions in cash in the form of currency”.

This type of finance is normally best met by Treasury bills and government bonds (which presently offer low returns) and repurchase agreements – a form of short-term borrowing in these sorts of bonds. The shadow banking system then fills the gap in the absence of availability of other secure assets.

However these supply and demand explanations only tell part of the story.

The global environment is characterised by a small population) of individuals and institutions with large pools of money seeking safe returns; and, cash-poor individuals with stagnant incomes and a need for credit. One example of this is the growing investment class of securities based on private debt, for example credit cards, mortgage debt and small business loans.

Low inflation across the globe and governments not spending or encouraging investment in assets that offer good returns, means investors are limited in the ways they can currently make money.

The problems with and solutions for shadow banking

Shadow banking has made the task of governments more difficult. However it would be mistaken to assume that governments do not have some control over shadow banking. All levels of government are already linked to aspects of shadow banking whether they like it or not.

Local governments were stung by exposure to shadow banking practices in the lead up to the global financial crisis. Councils were persuaded to invest in a structured financial product that offered unrealistic, and deceptive returns.

The NSW government is currently following shadow banking trends by borrowing and partnering with asset managers to build long-term infrastructure like Westconnex and the Sydney Light Rail.

At the national level, the Rudd-Gillard Government followed trends that originated in shadow banking by developing institutions like the Clean Energy Finance Corporation and the National Broadband Network. Both policies tried to diversify the investment base in Australia, but have been held up by the Abbott-Turnbull governments.

Australia can’t do much to remedy global uncertainty. However, policies it pursues do link into shadow banking practices in multiple ways.

Policies that erode the standard employment relation and cut pay rates increase consumer demand for short-term credit products. This increases private debt for consumers, but feeds its attractiveness into an asset class for institutional investors.

Reserve Bank of Australia Governor, Phillip Lowe, was surprisingly strident in his critique of the cut to corporate tax rates and negative gearing last week. Reading between the lines you can sense frustration with the lack of attention on how Australia stands to benefit or lose from current global investment trends.

Institutional investors don’t need more piles of cash (via company tax cuts), they need ways to invest it. If you think about Australia from the perspective of institutional investors, it lacks a diverse range of assets (besides property!).

Australia only registers 17 specialised goods industries compared with 35 for New Zealand and 44 for Canada. Consequently, real estate and infrastructure debt are some of the only things available to sop up the pile of cash currently sloshing around the global economy.

This leads to claims that self-managed super funds (those run by institutional investors) are potentially exacerbating Sydney and Melbourne’s already expensive property market.

There are three growing areas of shadow banking: catastrophe bonds, which bet on the risk of natural disasters; renewable energy infrastructure banks, and build-to-rent investments. These examples offer the two sides of shadow banking.

Catastrophe bonds are parasitic in the way they provide finance – betting on the destruction from disasters. Renewable energy and build-to-rent show the potential for using finance for potentially progressive outcomes, to provide sustainable energy and housing. Australia could harness this progressive side of finance to create a more diverse economy.

Author: Huon Curtis, Senior Research Analyst, University of Technology Sydney

Shadow banking increases the risk of another global financial crisis

From The Conversation.

Banks may still be evading increased regulation by shifting activities to shadow banking. This system is well established as part of the financial sector, but it provides products that separate an investor from an investment, making it more difficult to evaluate risk and value.

This lack of transparency increases the risk in our financial system overall, making it vulnerable to the types of shocks that caused the 2008 global financial crisis. A current example is the so-called “bespoke tranche opportunity” offered by shadow banks. This is similar to the notorious collateralised debt obligations, packages made up of thousands of mortgage loans some of which were sub-prime, blamed for the global financial crisis.

Shadow banking is comprised of hedge funds, private equity funds, mutual funds, pension funds and endowments, insurance and finance companies providing financial intermediation without explicit public liquidity and credit guarantees from governments. Shadow banking is usually located in lightly regulated offshore financial centres.

In the period leading up to the global financial crisis, a large portion of financing of securitised assets that allowed regulated banks to exceed limitations on their risk-taking was handled by the shadow banking sector.

To this day, shadow banking continues to make a significant contribution to financing the real economy. For example, according to the Financial Stability Board, in 2013 shadow banking assets represented 25% of total financial system assets. While the average annual growth in assets of banks (2011-2014) was 5.6%, shadow banking growth stood at 6.3%.

A comparison of country-based share of shadow banking assets between 2010 and 2014 reveals the largest rise for China from 2% to 8%, while the USA maintains its dominance of the shadow banking markets with around 40%.

The failure of private sector guarantees to help shadow banking endure the global financial crisis can be traced to underestimated tail risks by credit rating agencies, risk managers and investors. Credit rating agencies lack of transparency, when it comes to explaining their methods (often disguised as “commercial-in-confidence”), continue to make it difficult for a third party to check assessments.

An excess supply of inexpensive credit also contributed to risk before the global financial crisis of 2008. This was because investors overestimated the value of private credit and liquidity enhancements.

One of the key challenges for regulators now is to devise rules and standards requiring shadow markets to hold enough liquidity to be sufficiently sensitive to risk. However, where investors and financial intermediaries fail to identify new risks, it is less likely that the regulators – who have fewer resources – will succeed.

Raising capital requirements can limit the capacity of financial intermediaries to expand risky activities, although monitoring overall bank leverage may be better. This is because credit ratings cannot be relied upon in the presence of neglected risks. Similarly, monitoring rising exposure of regulated banks to shadow banking or untested financial innovations can also become part of the regulator’s arsenal.

But there remains a major problem that is unlikely to be resolved by any regulation. Regulation is meant to strike a fine balance between close supervision and allowing space for financial innovation because loss of diversity can create stronger channels of transmission and could expose financial systems to greater systemic risk.

Too little regulation encourages excessive risk taking, while too tight a regulation is bound to strangle the financial sector that provides the lifeline for the economy. Striking such a fine balance is next to impossible in a dynamic, global financial sector.

The Basel Accords, set up to strengthen regulation after the financial crisis, will continue to play a key role in helping manage systemic risk like this. For example regulations can collect data that would be useful in macroprudential regulation, taking action to reduce various risks and remaining alert to unfolding trends on the ground.

Regulators need to heed the trends in shadow banking as part of this, to ensure transparency. However the nature of this sector, the long chains and multiple counterparties with unclear financial obligations, will continue to make the job of the regulator very difficult.

Author: Necmi K Avkiran, Associate Professor in Banking and Finance, The University of Queensland

Transforming Shadow Banking into Resilient Market-based Finance

The “shadow banking system” worth at least $36 trillion in 2014 globally, can broadly be described as “credit intermediation involving entities and activities (fully or partially) outside the regular banking system” or non-bank credit intermediation in short. Such intermediation, appropriately conducted, provides a valuable alternative to bank funding that supports real economic activity. But experience from the crisis demonstrates the capacity for some non-bank entities and transactions to operate on a large scale in ways that create bank-like risks to financial stability (longer-term credit extension based on short-term funding and leverage). Such risk creation may take place at an entity level but it can also form part of a chain of transactions, in which leverage and maturity transformation occur in stages, and in ways that create multiple forms of feedback into the regular banking system.

The Financial Stability Board has been established to coordinate at the international level the work of national financial authorities and international standard setting bodies and to develop and promote the implementation of effective regulatory, supervisory and other financial sector policies in the interest of financial stability. It brings together national authorities responsible for financial stability in 24 countries and jurisdictions, international financial institutions, sector-specific international groupings of regulators and supervisors, and committees of central bank experts.

The FSB is chaired by Mark Carney, Governor of the Bank of England. Its Secretariat is located in Basel, Switzerland, and hosted by the Bank for International Settlements. Their latest reports address the future regulation of shadow banking.

Progress report on Transforming Shadow Banking into Resilient Market-based Finance: This report sets out actions taken to implement the FSB’s two-pronged strategy to address financial stability concerns associated with shadow banking over the past year, and next steps.
Global Shadow Banking Monitoring Report 2015: This report presents the results of the FSB’s fifth annual monitoring exercise to assess global trends and risks of the shadow banking system, reflecting data as of end-2014. It covers 26 jurisdictions and the euro area, representing about 80% of global GDP and 90% of global financial system assets.
Regulatory framework for haircuts on non-centrally cleared securities financing transactions: This report finalises policy recommendations in the framework for haircuts on certain non-centrally cleared securities financing transactions published in October 2014 to apply numerical haircut floors to non-bank-to-non-bank transactions and update the implementation dates of these recommendations. The framework aims to address financial stability risks in securities financing transactions.

In addition, in the coming days, the FSB will publish Standards and processes for global securities financing data collection and aggregation.

The reports published today mark further progress in the FSB’s two-pronged strategy in the following three ways that are in accordance with the actions and deadlines set out in the updated Roadmap towards strengthened oversight and regulation of shadow banking endorsed by the G20 Leaders at the Brisbane Summit in November 2014.

First, with regard to system-wide monitoring to track developments in the shadow banking system, the FSB has introduced this year a new activity-based “economic function” approach in its annual monitoring (ref. (ii) above). The approach helps narrow the focus to those parts of the non-bank financial sector where shadow banking risks may arise and may need appropriate policy responses to mitigate these risks. The first results of this approach, which will be further refined going forward, suggest:

The new activity-based, narrow measure of shadow banking was $36 trillion in 2014, increasing by $1.1 trillion compared to 2013. This is equivalent to about 30% of the overall non-bank financial sector assets and 60% of the GDP of the 26 participating jurisdictions.
The shadow banking activity based on this narrow-measure largely occurred in advanced economies, although growth is rapid in a number of emerging market economies. Credit intermediation associated with collective investment vehicles comprised 60% of the narrow aggregate and has grown by nearly 10% on average annually over the past four years.
In 2014, the wider aggregate comprising “Other Financial Intermediaries” in 20 jurisdictions and the euro area grew to reach $80 trillion, from $78 trillion in 2013. This wider measure outpaced growth in other categories of financial intermediation and the overall economy.

Second, there has been further progress this year to strengthen oversight and regulation of shadow banking, particularly in the area of securities financing. With the publication of the final standard, the regulatory framework for haircuts on non-centrally cleared securities financing transactions is complete, with the scope extended to cover securities financing between non-banks (ref. (iii) above). The standards and processes for global securities financing data collection will increase the transparency of these important financing markets.

Third, the implementation of previously agreed policies is progressing. It is essential for the agreed policies to be implemented in a timely manner, and the FSB, in coordination with the relevant standard-setting bodies, will continue to monitor the national implementation of agreed policies to ensure they achieve the intended objectives. Since shadow banking activities take a variety of forms and continue to evolve, FSB members are also mindful of the need to periodically review the agreed policies.

Mark Carney, Chair of the FSB said “Non-bank financing is a welcome additional source of credit to the real economy. The FSB’s efforts to transform shadow banking into resilient market-based finance, through enhanced vigilance and mitigating financial stability risks, will help facilitate sustainable economic growth”.

Glenn Stevens, Chair of the FSB Standing Committee on Assessment of Vulnerabilities said “The annual shadow banking monitoring exercise is an important mechanism for identifying potential financial system vulnerabilities in the non-bank sector. The activities-based approach in this year’s report enhances our understanding of the evolving composition of this sector and potential risks”.

Daniel Tarullo, Chair of the FSB Standing Committee on Supervisory and Regulatory Cooperation said “The extension of the scope of the securities financing regulatory haircut floor framework to cover transactions between non-banks will limit regulatory arbitrage and prevent the build-up of excessive leverage and liquidity mismatch in the non-bank financial system”.

Shadow Banking And Monetary Policy

The Bank of England just published a research paper “Do contractionary monetary policy shocks expand shadow banking?”

We previously discussed the role and importance of shadow banking, making the point that up to the 1980s, traditional banks were the dominant institutions in intermediating funds between savers and borrowers. However, since then, the role of market-based intermediaries has steadily increased. Whilst shadow banking cannot be defined as a homogenous, well-defined category, it embrances at least three types of intermediaries: asset-backed (ABS) issuers, finance companies, and funding corporations. In addition, shadow banking sector involves a web of financial institutions and a range of securitisation and funding techniques, and these activities are often closely intertwined with the traditional banking and insurance institutions. These interlinkages can involve back-up lines of credit, implicit guarantees to special purpose vehicles and asset management subsidiaries. So, given the focus on greater banking system regulation, and the role of monetary policy in this, the question is, does tighter monetary policy flow on to impact shadow banking. Is so, how?

Using detailed modelling, they find that monetary policy shocks do seem to affect the balance sheets of both commercial banks and their unregulated counterparts in the shadow banking sector. However, a monetary contraction aimed at reducing the asset growth of commercial banks would tend to cause a migration of activity beyond the regulatory perimeter to the shadow banking sector. In fact the monetary response needed to lean against shadow bank asset growth is of opposite to that needed to lean against commercial bank asset growth.

This means that monetary policy designed to control commercial banking may, as an unintended consequence, increase shadow banking activity (and so work against the policy intent). Therefore, they suggest that authorities should continue to develop a set of regulatory tools, complementary to monetary policy, that (a) seek to moderate excessive swings in risk-taking by commercial banks, as embodied in recent macroprudential frameworks, and (b) seek to strengthen oversight and regulation of the shadow banking sector. Monetary policy alone is not enough.