Info Service on Finance and Development (Nov12/05)
30 November 2012
Third World Network
FSB sets out recommendations on shadow banking
Published in SUNS #7487 dated 26 November 2012
Geneva, 23 Nov (Kanaga Raja) -- The Financial Stability Board (FSB)
has this week published three consultative documents containing policy
recommendations aimed at strengthening the oversight and regulation
of the shadow banking system.
In a press release, the FSB said that the three documents are open
for public consultation, with comments on the recommendations contained
in these documents to be submitted by 14 January 2013.
According to the press release, the three documents are:
-- a report titled "An Integrated Overview of Policy Recommendations"
setting out the FSB's overall approach to shadow banking issues, as
well as an overview of its recommendations;
-- a report titled "Policy Framework for Strengthening Oversight
and Regulation of Shadow Banking Entities", which sets out a
high-level policy framework to assess and mitigate bank-like systemic
risks posed by shadow banking entities other than money market funds
-- a report titled "Policy Recommendations to Address Shadow
Banking Risks in Securities Lending and Repos", which outlines
13 recommendations to enhance transparency, strengthen regulation
of securities financing transactions, and improve market structure.
According to the FSB, it has focused on five specific areas in which
it believes policies are needed to mitigate the potential systemic
risks associated with shadow banking: (i) to mitigate the spill-over
effect between the regular banking system and the shadow banking system;
(ii) to reduce the susceptibility of money market funds (MMFs) to
"runs"; (iii) to assess and mitigate systemic risks posed
by other shadow banking entities; (iv) to assess and align the incentives
associated with securitisation; and (v) to dampen risks and pro-cyclical
incentives associated with secured financing contracts such as repos,
and securities lending that may exacerbate funding strains in times
The FSB said that the Basel Committee on Banking Supervision (BCBS)
will develop policy recommendations for area (i) by mid-2013, while
for areas (ii) and (iv), the International Organisation of Securities
Commissions (IOSCO) has set out final policy recommendations in its
reports "Policy Recommendations for Money Market Funds"
and "Global Developments in Securitisation Markets."
In the first document, "An Integrated Overview of Policy Recommendations",
the FSB said that the "shadow banking system" can broadly
be described as "credit intermediation involving entities and
activities (fully or partially) outside the regular banking system".
While such intermediation, appropriately conducted, provides a valuable
alternative to bank funding that supports real economic activity,
the FSB said that "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 complex chain of transactions, in which leverage and
maturity transformation occur in stages, and in ways that create multiple
forms of feedback into the regulated banking system, it added.
Like banks, a leveraged and maturity-transforming shadow banking system
can be vulnerable to "runs" and generate contagion risk,
thereby amplifying systemic risk. Such activity, if unattended, can
also heighten pro-cyclicality by accelerating credit supply and asset
price increases during surges in confidence, while making precipitate
falls in asset prices and credit more likely by creating credit channels
vulnerable to sudden losses of confidence.
According to the FSB, these effects were powerfully revealed in 2007-09
in the dislocation of asset-backed commercial paper (ABCP) markets,
the failure of an originate-to-distribute model employing structured
investment vehicles (SIVs) and conduits, "runs" on money
market funds (MMFs) and a sudden reappraisal of the terms on which
securities lending and repos were conducted.
"But whereas banks are subject to a well-developed system of
prudential regulation and other safeguards, the shadow banking system
is typically subject to less stringent, or no, oversight arrangements,"
The FSB said it is of the view that the authorities' approach to shadow
banking has to be a targeted one.
"The objective is to ensure that shadow banking is subject to
appropriate oversight and regulation to address bank-like risks to
financial stability emerging outside the regular banking system while
not inhibiting sustainable non-bank financing models that do not pose
such risks. Indeed, a resilient system of non-bank credit intermediation
would be welcomed."
The approach is designed to be proportionate to financial stability
risks, focusing on those activities that are material to the system,
using as a starting point those that were a source of problems during
the crisis. It also provides a process for monitoring the shadow banking
system so that any rapidly growing new activities that pose bank-like
risks can be identified early and, where needed, those risks addressed.
At the same time, given the interconnectedness of markets and the
strong adaptive capacity of the shadow banking system, it is apparent
that any proposals in this area necessarily have to be comprehensive,
the FSB underlined, adding that a "piecemeal or incomplete approach
would be quickly arbitraged."
FSB members believe that the recommendations developed across these
areas represent a major step forward and present the G20 with concrete
proposals. If taken forward, these will provide a significant measure
of additional protection against "runs" in the shadow banking
sector of a type that exacerbated pro-cyclicality and added to systemic
risk in the years leading to 2007/8.
"So looking ahead, authorities must be mindful that, by strengthening
the capital and liquidity requirements applying to banks (an essential
pillar of the G20's financial reform programme), the Basel III framework
may increase the incentives for some bank-like activities to migrate
to the non-bank financial space. Other forms of regulatory reform
may have similar effects."
The FSB therefore believes that oversight and regulation for shadow
banking must incorporate a system of "embedded vigilance"
through on-going review and be capable of evolving in response to
Since the crisis, the FSB pointed out, BCBS members have implemented
or are in the process of implementing a number of measures (through
Basel II. 5 and Basel III) that should strengthen the resilience of
the banking sector against some risks posed by shadow banks.
In particular, the BCBS has: increased the capital requirements applied
to banks' re-securitisation exposures and for liquidity facilities
(under one year) provided to securitisation vehicles; increased the
capital requirements under the internal ratings-based approach (IRB)
for exposures to regulated financial institutions whose total assets
are greater than or equal to US$100 billion, and to unregulated financial
institutions, regardless of size; enhanced the banks' internal capital
adequacy assessment process under Pillar 2 for securitisation risk,
reputational risk and implicit support; and enhanced the Pillar 3
disclosure requirements related to securitisation.
Meanwhile, the FSB also released this week its second annual "Global
Shadow Banking Monitoring Report", whose coverage this year has
been broadened to include 25 jurisdictions and the euro area as a
whole, as opposed to 11 jurisdictions and the euro area as a whole
The FSB said that the addition of new jurisdictions brings the coverage
of the monitoring exercise to 86% of global GDP and 90% of global
financial system assets.
According to FSB, among the main findings from the report are:
-- The global shadow banking system grew rapidly before the crisis,
rising from $26 trillion in 2002 to $62 trillion in 2007. The size
of the total system declined slightly in 2008 but increased subsequently
to reach $67 trillion in 2011
(equivalent to 111% of the aggregated GDP of all jurisdictions).
Compared to last year's estimate, expanding the coverage of the monitoring
exercise has increased the global estimate for the size of the shadow
banking system by some $5 to $6 trillion. The newly included jurisdictions
contributing most to this increase were Switzerland ($1.3 trillion),
Hong Kong ($1.3 trillion), Brazil ($1.0 trillion) and China ($0.4
-- The shadow banking system's share of total financial intermediation
has decreased since the onset of the crisis and has remained at around
25% in 2009-2011, after having peaked at 27% in 2007. In broad terms,
the aggregate size of the shadow banking system is around half the
size of banking system assets.
The US has the largest shadow banking system, with assets of $23 trillion
in 2011, followed by the euro area ($22 trillion) and the UK ($9 trillion).
However, the US' share of the global shadow banking system has declined
from 44% in 2005 to 35% in 2011. This decline has been mirrored mostly
by an increase in the shares of the UK and the euro area.
-- There is a considerable divergence among jurisdictions in terms
of: (i) the share of non-bank financial intermediaries (NBFIs) in
the overall financial system; (ii) relative size of the shadow banking
system to GDP; (iii) the activities undertaken by the NBFIs; and (iv)
recent growth trends.
The Netherlands (45%) and the US (35%) are the two jurisdictions where
NBFIs are the largest sector relative to other financial institutions
in their systems. The share of NBFIs is also relatively large in Hong
Kong (around 35%), the euro area (30%), Switzerland, the UK, Singapore,
and Korea (all around 25%).
Jurisdictions where NBFIs are the largest relative to GDP are Hong
Kong (520%), the Netherlands (490%), the UK (370%), Singapore (260%)
and Switzerland (210%). Part of this concentration can be explained
by the fact that these jurisdictions are significant international
financial centres that host activities of foreign-owned institutions.
-- After the crisis (2008-2011), the shadow banking system continued
to grow although at a slower pace in seventeen jurisdictions (half
of them being emerging markets and developing economies undergoing
financial deepening) and contracted in the remaining eight jurisdictions.
-- Among the jurisdictions where data is available, interconnectedness
risk tends to be higher for shadow banking entities than for banks.
Although further analysis may be needed with more cross-border and
prudential information, shadow banking entities seem to be more dependent
on bank funding and are more heavily invested in bank assets, than
The FSB also said that data granularity is improving, with the share
of unidentified non-bank financial intermediaries within overall non-bank
intermediation falling from 36% in 2010 to 18% in 2011.
However, it added, further improvements are needed in jurisdictions
that still lack granular data to adequately capture the magnitude
and nature of risks in the shadow banking system. +