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FSB Confirms 2016 GSIBs

The Financial Stability Board (FSB), in consultation with the Basel Committee on Banking Supervision (BCBS) and national authorities, today published the 2016 list of global systemically important banks (G-SIBs).

The 2016 list comprises the same 30 banks as the 2015 list. Four banks moved to a higher bucket, and three banks moved to a lower bucket. The changes in the allocation across buckets of the institutions on the list reflect the combined effects of data quality improvements, changes in underlying activity, and the use of supervisory judgement.

G-SIBs are subject to:

Higher capital buffer requirements: Since the November 2012 update, the G-SIBs have been allocated to buckets corresponding to the higher capital buffers that they would be required to hold by national authorities in accordance with international standards. Higher capital buffer requirements began to be phased in from 1 January 2016 for G-SIBs that were identified in November 2014 (with full implementation by 1 January 2019). The capital buffer requirements for the G-SIBs identified in the annual update each November will apply to them as from January fourteen months later. The assignment of G-SIBs to the buckets in the list published today determines the higher capital buffer requirements that will apply to each G-SIB from 1 January 2018.

Total Loss-Absorbing Capacity (TLAC) requirements: G-SIBs will be required to meet the TLAC standard, alongside the regulatory capital requirements set out in the Basel III framework. The TLAC standard will be phased-in from 1 January 2019 for G-SIBs designated in the 2015 list (provided that they will continue to be designated as G-SIBs thereafter).

Resolvability requirements: These include group-wide resolution planning and regular resolvability assessments. The resolvability of each G-SIB is also reviewed in a high-level FSB Resolvability Assessment Process (RAP) by senior regulators within the firms’ Crisis Management Groups.

Higher supervisory expectations: These include supervisory expectations for risk management functions, risk data aggregation capabilities, risk governance and internal controls.

BIS, FSB and IMF publish elements of effective macroprudential policies

The International Monetary Fund (IMF), Financial Stability Board (FSB) and Bank for International Settlements (BIS) released today a new publication on Elements of effective macroprudential policies. The document, which responds to a G20 request, takes stock of the international experience since the financial crisis in developing and implementing macroprudential policies and will be presented to the G20 Leaders’ Summit in Hangzhou.

Following the global financial crisis, many countries have introduced frameworks and tools aimed at limiting systemic risks that could otherwise disrupt the provision of financial services and damage the real economy. Such risks may build-up over time or arise from close linkages and the distribution of risk within the financial system.

Experience with macroprudential policy is growing, complemented by an increasing body of empirical research on the effectiveness of macroprudential tools. However, since the experience does not yet span a full financial cycle, the evidence remains tentative. “The wide range of institutional arrangements and policies being adopted across countries suggest that there is no ‘one-size-fits-all’. Nonetheless, accumulated experience highlights – and this paper documents – a number of elements that have been found useful for macroprudential policy making,” the publication says. These include:

A clear mandate that forms the basis for assigning responsibility for taking macroprudential policy decisions.

Adequate institutional foundations for macroprudential policy frameworks. Many of the observed designs give the main mandate to an influential body with a broad view of the entire financial system.

Well-defined objectives and powers that can foster the ability and willingness to act.

Transparency and accountability mechanisms to establish legitimacy and create commitment to take action.

Measures to promote cooperation and information-sharing between domestic authorities.

A comprehensive framework for analysing and monitoring systemic risk as well as efforts to close information gaps.

A broad range of policy tools to address systemic risk over time and from across the financial system.

The ability to calibrate policy responses to risks, including by considering the costs and benefits, addressing any leakages, and evaluating responses. In financially integrated economies, this includes assessing potential cross-border effects.

The document includes some data on the use of macroprudential tools; illustrative examples of institutional models for macroprudential policymaking; and a brief summary of some of the empirical literature on the effectiveness of macroprudential tools.

“Usage” counts the number of countries using the various instruments that comprise each group. Assuming that once a country introduces an instrument, it continues using it, the charts show usage of the various groups of instruments.

Institutional arrangements adopted by a country are shaped by country-specific circumstances, such as political and legal traditions, as well as prior choices on the regulatory architecture. While there can therefore be no “one size fits all” approach, in practice, there has been an increasing prevalence of models that assign the main macroprudential mandate to a well-identified authority, committee, or interagency body, generally with an important role of the central bank. While each of these models has pros and cons, any one model can be buttressed with additional safeguards and mechanisms.

Model 1: The main macroprudential mandate is assigned to the central bank, with its Board or Governor making macroprudential decisions (as in the Czech Republic, Ireland, New Zealand and Singapore). This model is the prevalent choice where the central bank already concentrates the relevant regulatory and supervisory powers. Where regulatory and supervisory authorities are established outside the central bank, the assignment of the mandate to the central bank can be complemented by coordination mechanisms, such as a committee chaired by the central bank (as in Estonia and Portugal), information sharing agreements, or explicit powers assigned to the central bank to make recommendations to other bodies (as in Norway and Switzerland).

Model 2: The main macroprudential mandate is assigned to a dedicated committee within the central bank structure (as in Malaysia and the UK). This setup creates dedicated objectives and decision-making structures for monetary and macroprudential policy where both policy functions are under the roof of the central bank, and can help counter the potential risks of dual mandates for the central bank (see further IMF 2013a). It also allows for separate regulatory and supervisory authorities and external experts to participate in the decision-making committee. This can foster an open discussion of trade-offs that brings to bear a range of perspectives and helps discipline the powers assigned to the central bank.

Model 3: The main macroprudential mandate is assigned to an interagency committee outside the central bank, in order to coordinate policy action and facilitate information sharing and discussion of system-wide risk, with the central bank participating on the committee (as in France, Germany, Mexico, and the US). This model can accommodate a stronger role of the Ministry of Finance (MoF). Participation of the MoF can be useful to create political legitimacy and enable decision makers to consider policy choices in other fields, e.g. when cooperation of the fiscal authority is needed to mitigate systemic risk.

Partial Progress On Reforming Major Interest Rate Benchmarks – FSB

The Financial Stability Board (FSB) today published Reforming Major Interest Rate Benchmarks which provides a progress report on implementation of its July 2014 recommendations to reform major interest rate benchmarks.

The report finds progress has been made by the three major benchmarks of EURIBOR, LIBOR and TIBOR. Reflecting the systemic importance of these reference rates authorities in the European Union, Japan and United Kingdom have taken steps to regulate the administrators of the IBORs. Member authorities represented on the Official Sector Steering Group (OSSG), benchmark administrators and market participants from other jurisdictions, including Australia, Canada, Hong Kong, Mexico, Singapore and South Africa, have continued to take steps to improve the existing interbank rates in their own jurisdiction.

However, the report finds that while substantial progress has been made, the reforms of the IBORs have not been completed. Administrators should now focus on transition and decide how to anchor rates in transactions and objective market data as far as practicable. Similarly, it finds that more progress remains to be achieved in identifying risk-free rates (RFRs) and promoting their use where appropriate. Where groups have been set up to identify a single alternative and to promote its use, the final choice has yet to be made and transition planning is still in preliminary stages.

The major interest reference rates are widely used in the global financial system as benchmarks for a large volume and broad range of financial products and contracts. The cases of attempted market manipulation and false reporting of global reference rates lowered confidence in the reliability and robustness of existing benchmark interest rates. Uncertainty surrounding the integrity of these reference rates represented a potentially serious source of vulnerability and systemic risk. Against this background, in February 2013, the G20 asked the FSB to undertake a fundamental review of major interest rate benchmarks. In July 2014 the FSB published the recommendations for reform developed by the OSSG. The OSSG published its most recent progress report in July 2015.

FSB Regional Consultative Group for Asia discusses FSB priorities and financial reforms in the region

Bank Negara Malaysia hosted the tenth meeting of the Financial Stability Board (FSB) Regional Consultative Group (RCG) for Asia in Kuala Lumpur.

At their meeting, members of the FSB RCG for Asia began by reviewing the FSB’s work plan and 2016 policy priorities, namely: promoting full, consistent and timely implementation of the international financial reforms; finalising the design of the remaining post-crisis reforms; and addressing new risks and vulnerabilities. They next considered vulnerabilities in the global financial system, their potential impact on Asia and possible policy responses, and regional financial stability issues.

In terms of new risks and vulnerabilities, members discussed the latest developments in financial technology and implications for financial stability. Related to this, they exchanged views on the latest trends and challenges in cybersecurity, supervisory approaches to enhance information technology risk management at financial institutions and market infrastructures, and the need for cooperation in cyber intelligence sharing, both domestically and cross-border. This discussion drew upon a 19 May workshop that took place in Hong Kong organised by the RCG – and involving both the public and private sector – that focused on financial technology and cybersecurity.

Members next turned their attention to corporate governance and steps being taken by regulators to address weaknesses identified during the financial crisis. Members shared experiences on how a robust governance framework can help the allocation of authority and responsibilities in a firm, in particular to its board and senior management; monitor performance; and ensure employees conduct business in a legal and ethical manner. Members also discussed mechanisms for strengthening individual accountability, including the role and responsibilities of the board, management and control functions.

In December 2015, the Basel Committee on Banking Supervision issued a second consultative document on Revisions to the Standardised Approach for credit risk as part of its broader review of the capital framework to balance simplicity and risk sensitivity, and to promote comparability by reducing variability in risk-weighted assets across banks and jurisdictions. Members discussed the revised proposal, including the use of external credit ratings to determine risk weights and the risk weighting methodology for different classes of assets. They also considered how the new proposal will impact banking systems in Asia.

The meeting concluded with a session during which members shared experiences with the implementation of resolution regimes, including requirements for recovery and resolution planning for domestically systemically important financial institutions. As part of the discussion, members explored ways to facilitate cross-border cooperation in the event of resolution actions.

The FSB Regional Consultative Group for Asia is co-chaired by Mr Norman T. L. Chan, Chief Executive, Hong Kong Monetary Authority and Mr Ashraf Mahmood Wathra, Governor, State Bank of Pakistan. Membership includes financial authorities from Australia, Cambodia, China, Hong Kong SAR, India, Indonesia, Japan, Korea, Malaysia, New Zealand, Pakistan, Philippines, Singapore, Sri Lanka, Thailand and Vietnam.

The FSB has six Regional Consultative Groups, established under the FSB Charter, to bring together financial authorities from FSB member and non-member countries to exchange views on vulnerabilities affecting financial systems and on initiatives to promote financial stability.

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.

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.

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”.

New Total Loss Absorbing Capacity Standard for Global Banks Is Credit Positive – Moody’s

In Moody’s latest Credit Outlook, they discuss the impact of the new Total Loss Absorbing Capacity (TLAC) Standard for Global Banks.

Last Monday, the Financial Stability Board (FSB) published its standard for total loss absorbing capacity (TLAC), which sets forth the amount, composition and location of capital and debt required to meet bank recapitalization needs in a resolution. The standard prompts global systemically important banks (G-SIBs) to increase the resources available to absorb losses beyond the regulatory capital requirements and buffers embedded in the Basel III framework, a credit positive.

The TLAC framework aims to ensure that banks maintain sufficient loss-absorbing instruments (both capital and eligible long-term debt) to absorb losses and recapitalize a bank in a resolution without the use of public funds and to reduce the chance of systemic disruption. The TLAC standard applies to the 30 institutions that the FSB designated as G-SIBs, although national regulators might also require non-G-SIBs to conform with the global standard. Firms will be required to meet TLAC standards alongside regulatory capital requirements and buffers set out in the Basel III framework.

The FSB set an initial level of TLAC at 16% of risk-weighted assets (RWAs) and 6% of the leverage exposure (the denominator of the Basel III leverage ratio) starting 1 January 2019. This will rise to 18% of RWAs and 6.75% of leverage exposure starting 1 January 2022. The 1 January 2019 start date should provide banks with sufficient time to reach the required levels.

Chinese G-SIBs have been exempted from the initial TLAC deadlines given the still-low levels of demand among Chinese non-bank investors for fixed-income assets, which constrains the extent to which banks can issue substantial volumes of capital and debt instruments. Nevertheless, Chinese G-SIBs will be required to meet the first benchmark – 16% of RWAs and 6% of leverage exposure – by 1 January 2025, and the 18% of RWAs and 6.75% of leverage exposure requirement by 1 January 2028.

TLAC can comprise a range of instruments, from equity to long-term senior debt. Senior holding company debt should typically be eligible as TLAC owing to its structural subordination. The guideline contemplates the eligibility of senior unsecured bank debt normally ranking pari passu with excluded liabilities such as derivative liabilities and short-term deposits by allowing senior bank debt of up to 2.5% of RWAs in 2019 and 3.5% in 2022 issued by institutions subject to resolution regimes that provide for partial or complete exclusion of the pari passu liabilities from bail-in. However, it remains unclear how the preconditions for the eligibility of senior bank debt would be fulfilled. In particular, the inclusion of such debt must not give rise to material risk of legal challenge under the no creditor worse off principle.

The Basel Committee on Banking Supervision estimated that for a sample of 29 G-SIBs based on last year’s G-SIB list, the average eligible external TLAC ratio at the end of 2014 was 13.1% of RWAs and 7.2% of the leverage exposure. This estimate assumed no bank-issued senior debt would be eligible as TLAC, and revealed that only six banks met the 16% TLAC requirement. The aggregate shortfall to the 2022 TLAC requirements totals €1.1 trillion for all 30 G-SIBs, or €755 billion when excluding the Chinese G-SIBs. For banks subject to operational resolution regimes, which include all US and European G-SIBs, the introduction of TLAC requirements will benefit depositors and other senior unsecured creditors because of a larger cushion available to absorb losses at failure from the issuance of more subordinated securities.

Additionally, other things being equal, a larger layer of any given class of debt will benefit the ratings of that class, given that potential losses would be spread over a larger pool of investors. This could be somewhat offset by an increased reliance on wholesale funding, and a weakening of profitability should funding costs increase. However, we do not expect a material effect on those metrics.

FSB Updates G-SIB List

The FSB and the Basel Committee on Banking Supervision (BCBS) have updated the list of global systemically important banks (G-SIBs), using end-2014 data and the updated assessment methodology published by the BCBS in July 2013. One bank has been added to and one bank has been removed from the list of G-SIBs that were identified in 2014, and therefore the overall number of G-SIBs remains 30. None are Australian.

The changes in the institutions included in the list and in their allocation across buckets reflect the combined effects of data quality improvements, changes in underlying activity, and the use of supervisory judgement.

In November 2011 the Financial Stability Board published an integrated set of policy measures to address the systemic and moral hazard risks associated with systemically important financial institutions (SIFIs). In that publication, the FSB identified as global SIFIs (G-SIFIs) an initial group of G-SIBs, using a methodology developed by the BCBS. The November 2011 report noted that the group of G-SIBs would be updated annually based on new data and published by the FSB each November.

Since the November 2012 update, the G-SIBs have been allocated to buckets corresponding to the higher loss absorbency requirements that they would be required to hold. The higher loss absorbency requirements begin to be phased in from 1 January 2016 for G-SIBs that were identified in November 2014 (with full implementation by 1 January 2019). The higher loss absorbency requirements for the G-SIBs identified in the annual update each November will apply to them as from January fourteen months later. The assignment of the G-SIBs to the buckets in the updated list published today determines the higher loss absorbency requirement that will apply to each G-SIB from 1 January 2017.

G-SIBs in the updated list will be required to meet a new standard on Total Loss Absorbing Capacity (TLAC) alongside regulatory capital requirements set out in the Basel III framework.4 The new TLAC standard will be phased-in as from 1 January 2019.

G-SIBs are also subject to: Requirements for group-wide resolution planning and regular resolvability assessments. In addition, the resolvability of each G-SIB is also reviewed in a high-level FSB Resolvability Assessment Process (RAP) by senior policy-makers within the firms’ Crisis Management Groups. Higher supervisory expectations for risk management functions, risk data aggregation capabilities, risk governance and internal controls.

Since November 2013 the BCBS has published the denominators used to calculate banks’ scores, and the thresholds used to allocate the banks to buckets.6 In November 2014 the BCBS published a technical summary of the methodology, as well as the links to the GSIBs’ public disclosures. Starting this year, the BCBS also publishes and provides the links to the public disclosures of the full sample of banks assessed, as determined by the sample criteria set out in the BCBS G-SIB framework.

The list of G-SIBs will be next updated in November 2016.

HSBC
JP Morgan Chase
Barclays
BNP Paribas
Citigroup
Deutsche Bank
Bank of America
Credit Suisse
Goldman Sachs
Mitsubishi UFJ FG
Morgan Stanley
Agricultural Bank of China
Bank of China
Bank of New York Mellon
China Construction Bank
Groupe BPCE
Groupe Crédit Agricole
Industrial and Commercial Bank of China Limited
ING Bank
Mizuho FG
Nordea
Royal Bank of Scotland
Santander
Société Générale
Standard Chartered
State Street
Sumitomo Mitsui FG
UBS
Unicredit Group
Wells Fargo

Financial Stability Board (FSB) peer review of China

The Financial Stability Board (FSB) published today its peer review of China. The review concludes that the authorities have made good progress in addressing the FSAP recommendations on both topics, but that there is additional work to be done. A unifying theme behind the findings and recommendations is the need for closer coordination and information sharing between the authorities to handle a dynamic financial system. The report published today describes the findings and conclusions of the peer review of China. The draft report was prepared by a team of experts drawn from FSB member institutions and led by Jon Cunliffe, Deputy Governor of the Bank of England.

The peer review examined two topics relevant for financial stability and important for China: the macroprudential management framework and non-bank credit intermediation. The review focused on the steps taken by the authorities to implement reforms in these areas, including by following up on relevant recommendations in the 2011 Financial Sector Assessment Program (FSAP) report by the International Monetary Fund (IMF) and the World Bank.

The peer review concludes that the authorities have made good progress in addressing the FSAP recommendations on both topics, but that there is additional work to be done. A unifying theme behind the peer review findings and recommendations (see below) is the need for closer coordination and information sharing between the authorities to handle a dynamic financial system. Enhancing inter-agency coordination and developing an integrated risk assessment framework will promote a common understanding of objectives and risks, which will in turn facilitate joint policy actions and public communication.

In particular, the peer review found that the People’s Bank of China and financial sector regulatory agencies (China Banking Regulatory Commission, China Securities Regulatory Commission and China Insurance Regulatory Commission) have made important strides in developing a macroprudential management framework. Notable achievements include the elaboration of monitoring frameworks and toolkits by each agency to assess systemic risk in the sectors under their respective mandates; data improvements and ongoing work to develop a shared statistical platform; and enhanced inter-agency coordination through the Financial Crisis Response Group directly under the State Council and the Financial Regulatory Coordination Joint Ministerial Committee (JMC). Importantly, the authorities have a broad range of tools that can be used for macroprudential purposes, and have deployed them frequently in response to economic and financial system developments.

Building on what has been done to date, and as is being grappled with in many jurisdictions, additional work is needed to flesh out and operationalise a comprehensive and coordinated macroprudential policy framework. The peer review recommends:

Clarifying the mandate and roles of different inter-agency bodies in assessing systemic risks and designing macroprudential policies, and strengthening the supporting infrastructure accordingly.

Further developing an integrated systemic risk assessment framework that incorporates the views of different agencies and takes into account cross-sectoral policy interactions and implications for the overall stance of macroprudential policy.

Developing an inter-agency protocol specifically for financial stability monitoring/assessment and related information sharing, based on the respective role of each authority in the macroprudential policy framework.

Publishing the outcome of key inter-agency meetings and deliberations periodically as a means of communicating the authorities’ macroprudential outlook and policy stance.

Non-bank credit intermediation has accounted for an increasing proportion of funding to the Chinese economy – around 20% of new financing flows over the period 2012-14 – although the most recent figures indicate that its growth has moderated. The peer review found that the authorities have improved their monitoring of non-bank credit intermediation in recent years and have taken steps to contain identified risks. Specific examples include the augmentation of data collection, enhanced cooperation between the authorities via the JMC, and policy actions to mitigate identified risks related to the interbank market, the trust sector and banks’ wealth management products.

Notwithstanding these accomplishments, challenges remain in assessing and mitigating emerging risks in this sector – both in terms of data collection and, more importantly, in terms of undertaking coordinated and comprehensive risk assessments to inform the use of policy tools. This is not unique to China, as many other jurisdictions are in the process of improving their monitoring and developing policy tools to ensure that non-bank activities develop into a transparent, resilient and sustainable source of market-based financing. The peer review recommends that the authorities:

Continue to enhance efforts to collect and disclose comprehensive and granular data relating to non-bank credit intermediation (e.g. on various forms of wealth and asset management products), and routinely share them for risk monitoring purposes.

Enhance their ability to assess systemic risks stemming from non-bank credit intermediation by extending the analytical framework to focus on the liquidity, maturity transformation, credit and reputational risks for banks stemming from these products, the impact of second-round effects, and the use of crisis simulation exercises.

Develop a more activity-based regulatory approach in order to discourage regulatory arbitrage and ensure a level playing field in non-bank credit intermediation.

Continue to promote a more diversified and resilient financial system by increasing reliance on market-based pricing mechanisms via the removal of implicit guarantees, and by further developing capital markets and an institutional investor base as an alternative pillar to bank financing.

Will Shadow Banking Regulation Be Sufficient?

The Financial Stability Board (FSB) has launched a peer review on the implementation of its policy framework for financial stability risks posed by non-bank financial entities other than money market funds (“other shadow banking entities”). The objective of the review is to evaluate the progress made by FSB jurisdictions in implementing the overarching principles set out in the framework – in particular, to assess shadow banking entities based on economic functions, to adopt policy tools if necessary to mitigate any identified financial stability risks, and to participate in the FSB information-sharing process. However, DFA’s initial take is that the proposed approach is relatively light-handed, and may not be sufficient. You can read our analysis of shadow banking and why it should be better regulated here.

The summarized terms of reference provide more details on the objectives, scope and process of this review. A questionnaire to collect information from national authorities has been distributed to FSB members. The responses will be analysed and discussed by the FSB later this year. The peer review report will be published in early 2016.

As part of this peer review, the FSB invites feedback from financial institutions, industry and consumer associations as well as other stakeholders on the areas covered by the peer review. This could include comments on:

institutional arrangements needed to define and update the regulatory perimeter to capture new forms of shadow banking if necessary to ensure financial stability;
types of information that may be necessary to assess shadow banking risks for entities identified as having the potential to pose risks to the financial system;
possible ways to enhance public disclosure of shadow bank entities’ risks; and
the design of policy tools to mitigate identified financial stability risks.

Feedback should be submitted by 24 July 2015. Individual submissions will not be made public.

Transforming shadow banking into resilient market-based finance is one of the core elements of the FSB’s regulatory reform agenda to address the fault lines that contributed to the global financial crisis and to build safer, more sustainable sources of financing for the real economy. The FSB has adopted a two-pronged strategy to deal with these fault lines. First, it has created a system-wide monitoring framework to track financial sector developments outside the banking system with a view to identifying the build-up of systemic risks and initiating corrective actions where necessary. Second, it is coordinating and contributing to the development of policy measures in five areas where oversight and regulation need to be strengthened to reduce excessive build-up of leverage, as well as maturity and liquidity mismatch, in the system.

One of these five areas is assessing and mitigating financial stability risks posed by non-bank financial entities other than money market funds (“other shadow banking entities”). Based on the G20 Roadmap agreed at the St Petersburg Summit, the FSB developed a high-level policy framework for other shadow banking entities in August 2013. The framework focuses on the underlying economic functions (i.e. activities) of non-bank financial entities instead of their legal forms, and sets forth key overarching principles that authorities should adhere to in their oversight of non-bank financial entities that are identified as posing shadow banking risks that threaten financial stability.

FSB and Financial Benchmarks

The FSB published an interim progress report on reforms to existing major interest rate benchmarks (such as LIBOR, EURIBOR and TIBOR, collectively the “IBORs”) and in the development and introduction of alternative near risk-free interest rate benchmarks (termed “RFRs”). The Reserve Bank of Australia (RBA) is working with AFMA and ASIC, to develop a risk-free benchmark for the Australian dollar.

The report examines progress toward the FSB’s recommendations for reforms in this area, developed by the Official Sector Steering Group (OSSG) and published in July 2014, namely:

There should be a strengthening in existing IBORs and other reference rates based on unsecured bank funding costs by underpinning them to the greatest extent possible with transactions data. These enhanced rates are termed “IBOR+”.
Steps should be taken to develop alternative RFRs, given that there are certain financial transactions, including many derivatives transactions, that are better suited to reference rates that are closer to risk-free.[1]

Since July 2014, the administrators of the most widely used IBORs – EURIBOR, LIBOR and TIBOR – have all taken major steps in this regard. These steps have included reviews of respective benchmark methodologies and definitions, data collection exercises and feasibility studies, consideration of transitional and legal issues, and broad consultations with submitting banks, users and other stakeholders.

While the FSB recommendations were directed at the three major IBORs, OSSG member authorities, benchmark administrators and market participants from other jurisdictions, including Australia, Canada, Hong Kong, Mexico, Singapore and South Africa, have also taken steps towards reforming the existing rates in their own jurisdiction, given the importance of these rates to their domestic markets and their role as international financial centres.

With regards to the Australian dollar, the Reserve Bank of Australia (RBA) is working with AFMA and ASIC, to develop a risk-free benchmark. Using OIS would allow a term RFR but raises issues around construction of a robust benchmark. An alternative realised rate-based synthetic term reference rate, based on ex post compounding of the overnight cash rate (which already exists as a robust overnight RFR), does not raise these issues but it is unclear if it would be as useful to market participants. Progress on this is occurring with the aim to have such a benchmark operational by Q2 2016. Once a risk-free benchmark is operational, the RBA will work with market participants, AFMA and ASIC to coordinate a transition towards referencing such a rate, rather than a credit rate, where appropriate. The market has demonstrated a general willingness to participate in this process.

OSSG members have also made concrete progress in identifying potential RFRs. In particular, detailed data collection exercises have been undertaken in key markets, and work is now underway to identify potential RFRs, where these do not currently exist. In addition to authorities in the euro area, Japan, UK and US, several other OSSG members are also working with industry in local markets to develop RFRs in their respective currencies.

The OSSG will continue to monitor progress in implementing the FSB’s recommendations in the year ahead, and will prepare an updated progress report for publication by the FSB in July 2016.

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. The FSB also conducts outreach with approximately 65 other jurisdictions through its six regional consultative groups. 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.