The Financial Stability Board releases recommendations for monitoring shadow banking system.
The Financial Stability Board (FSB) on Thursday issued its recommendations for regulating the shadow banking system, the network of financial entities outside the regular banking system that some say contributed to the financial crisis. Although these entities compete with banks in providing credit, banks also use them to shift risk off their balance sheets; this is the area that the FSB is most concerned about.
The FSB is basically going to make bank use of the shadow banking system much more expensive, which in turn could impact corporate treasurers in their funding schemes. Lending is likely already getting expensive what with other areas of regulations crimping bank activities. The FSB recommendations will be finalized at the end of 2012.
Currently the size of the shadow banking system is back to pre-crisis levels of about $60tn, according to the FSB. The shadow banking system makes up about 25 – 30 percent of the total financial system and is around half the size of bank assets. The US takes up about half of that amount. And according to a recent Wall Street Journal report that cites Barclays Capital, China’s shadow banking system makes up about 22 percent of all new financing in China.
The FSB wants to regulate shadow banking because of its ability to tank the rest of the banking system in a crisis. This is through direct interactions and “through its interconnectedness with the regular banking system.” It can also create opportunities for arbitrage that undermine bank regulations.
In its latest recommendations, the FSB said regulators should focus on four key risk factors: (i) maturity transformation; (ii) liquidity transformation; (iii) imperfect credit risk transfer; and/or (iv) leverage. They should then assess the potential impact of a distressed or failed shadow banking entity.
The latest report also describes work plans for the five “workstreams” that the FSB released in September (see related story here), and how these areas will be further assessed for possible future action.
(i) Banks’ interactions with shadow banking entities (indirect regulation) which the Basel Committee will report on by July 2012;
(ii) Money market funds (MMFs), which the International Organization of Securities Commissions (IOSCO) will report on by July 2012;
(iii) Other shadow banking entities – to be reported on by September 2012;
(iv) Securitization – IOSCO, July 2012; and
(v) Securities lending and repos, December 2012
While the latest recommendations will probably dampen shadow banking use, they could be far worse. Some experts say regulatory authorities and governments don’t have the sufficient resources to handle an additional $60tn market. Some raise the prospect of doing away with it altogether.