Global plans to strengthen the regulatory oversight of shadow banking are nearing completion as the Financial Stability Board (FSB) released two new policy frameworks covering securities lending and supervision.
The latest proposals are part of the international community’s efforts since the global financial crises to tackle the threat from shadow banking, the vast and largely unregulated world of hedge funds, money market funds and investment vehicles.
The financial crises revealed that shadow banking - roughly half the size of the regulated banking sector - posed a severe threat to financial stability, not only because of its size and global reach but also because it is part of a complex chain of financial transactions with banks and insurance companies.
“ Like banks, a leveraged and maturity-transforming shadow banking system can be vulnerable to “runs” and create contagion risk, thereby amplifying systemic risk,” said the FSB, the international body that monitors and coordinates global financial regulation on behalf of the Group of 20 (G20) leading economies.
Over the last two years, the FSB has been developing a string of policies aimed at reducing the risk from shadow banking by creating a monitoring framework to track the sector and strengthen the oversight and regulation of the shadow banking system.
"Most of these policy measures are now finalised and will be adopted by FSB members in an internationally-coordinated manner," said the FSB, adding that some of its latest proposals that cover minimum haircuts for securities financing transactions would be refined further to avoid any unintended consequences for the financial system.
The challenge for the FSP, along with the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO), has been to devise rules that limit the risks yet retain the benefits and don’t stymie future financial innovation.
"When implemented, this integrated set of policies should mitigate financial stability risks emanating from shadow banking. They should also limit the incentives of risky activities to move to the unregulated sector as tighter regulations on banks and other traditional market participants come into effect," the FSB said.
While off-balance sheet financial entities and various forms of securitization have been around for centuries, the current form of shadow banking first took off in the last decades as banks exploited regulatory gaps and used regulatory arbitrage to minimize cost.