International Financial Stability Board Chair: Non-Bank Vulnerabilities Threaten Financial System

A top global financial watchdog says the “shadow banking” sector needs more regulation.

Writing Monday (July 22) to a group of finance ministers and central bank governors, Financial Stability Board (FSB) Chair Klaas Knot said recent “incidents of market stress and liquidity strains” have shown that non-bank financial institutions (NBFIs) can cause or worsen systemic risks to the larger financial system.

“Many of the underlying vulnerabilities that contributed to these incidents are still largely in place, leaving the global financial system susceptible to further shocks,” Knot wrote.

“While some progress has been made to date, the pace of implementation of agreed NBFI policies has been uneven across jurisdictions and we may already be losing momentum.”

NFBIs, also known as shadow banks, include hedge funds, private credit providers and other financing sources beyond the regulated banking system.

Data from the European Commission shows that European Union NBFIs held assets worth $46 trillion last year, compared to $41.1 trillion for traditional banks. The FSB says these groups held $218 trillion in 2022, or a little less than half the financial assets on the planet.

“To enhance the resilience of the global financial system, it is critical that we finalize NBFI reforms and strongly commit ourselves to full and timely implementation,” Knot wrote.

He added that the FSB plans to publish a consultation report with proposed policy solutions by the end of the year.

Knot is part of a larger group of regulators from both sides of the Atlantic warning that NFBIs need greater oversight. For example, European Banking Authority Chairman Jose Manuel Campa said recently that the watchdog group is considering reporting requirements for nonbank financial institutions.

And Michael Hsu, acting head of the Office of the Comptroller of the Currency, argued earlier this year that the loosely regulated lenders were leading banks to make lower-quality and higher-risk loans.

“We need to solve the race to the bottom,” Hsu said. “And I think part of the way to solve it is to put due attention on those non-banks.”

Meanwhile, PYMNTS wrote earlier this month that as regulators place more focus on the NBFI sector, traditional financial institutions have begun behaving more like neobanks.

“Open banking looks set to transform financial services in the United States, and the approach, in contrast to what has been seen in Europe, is market-driven rather than government-driven,” that report said. “A spate of announcements has served to highlight digital innovations that are changing the ways accounts can be opened and bundled with other offerings that go beyond direct deposit.”