At the request of the G20, a Financial Stability Board task force (Task Force) has
published recommendations to strengthen the oversight and regulation of the shadow banking system. As we discussed in our April 28, 2011 post, "
FSB Task Force Frames the Regulation of Shadow Banking," the FSB formed a task force (Task Force) whose primary goal is to develop recommendations to strengthen the regulation and oversight of the shadow banking system by mid-2011.
This report follows an April 12, 2011 document, "
Shadow Banking: Scoping the Issues," clarify what is meant by the “shadow banking system” and set the stage for public comment and regulatory tracking.
Based on a detailed monitoring exercise to review recent trends and developments in the global shadow banking system and a regulatory mapping exercise to take stock of existing national and international initiatives, this latest report,
Shadow Banking: Strengthening Oversight and Regulation, takes on the main thrust of Task Force's mandate and recommends possible approaches for regulatory authorities to address the systemic risk and regulatory arbitrage concerns posed by the shadow banking system.
The Task Force report is broken into three parts:
- Part 1 outlines the overall approach being taken to strengthen the oversight and regulation of the shadow banking system;
- Part 2 sets out the details of the proposed recommendations for intensifying monitoring; and
- Part 3 set forth recommendations for enhancing regulation.
In designing their monitoring process, the Task Force recommends regulatory authorities first assess the broad scale and trends of non-bank credit intermediation in the financial system, drawing data sources such as flow of funds, sector balance sheet data, and supervisory data. Using the information drawn from the monitoring process, authorities are then called upon to focus on the types of non-bank credit intermediation potentially posing the greatest systemic risks, emphasizing four risk factors:
- maturity transformation;
- liquidity transformation;
- imperfect credit risk transfer; and/or
- leverage.
The report’s recommendations to strengthen regulation set out general principles for designing and implementing measures to address the risks identified by the monitoring process. The Task Force recommends that authorities then perform some stress testing on the interconnectedness between shadow banking and traditional banking by assessing the potential effects that sudden or severe distress or failure of certain shadow banking entities/activities would pose to the overall financial system.
Short on recommendations for specific regulatory measures, the report also describes plans for the five workstreams, which were
announced in September, that will assess in more detail the case for further regulatory action in areas where the Task Force requires more specificity:
- Banks’ interactions with shadow banking entities (indirect regulation) – The Basel Committee on Banking Supervision (BCBS) will examine enhanced consolidation for prudential regulatory purposes, concentration limits/large exposure rules, risk weights for banks’ exposures to shadow banking entities, and treatment of implicit support by July 2012;
- Money market funds (MMFs) – The International Organization of Securities Commissions (IOSCO) will examine regulatory action related to MMFs by July 2012;
- Other shadow banking entities – A new workstream set up under the FSB Task Force will examine shadow banking entities other than MMFs by September 2012;
- Securitisation – IOSCO, in coordination with the BCBS, will examine retention requirements and transparency by July 2012; and
- Securities lending and repos - A new workstream set up under the FSB Task Force will examine securities lending and repos (repurchase agreements) including possible measures on margins and haircuts by the end of 2012.
Drawing on this enhanced monitoring framework and the detailed recommendations from the five work streams, the FSB has committed to continue to assess global trends and risks associated with shadow banking, and produce guidance and recommendations. Adair Turner, the Chairman of the FSB Standing Committee on Supervisory and Regulatory Cooperation, said, “With regulation on banks tightened, it is important to address systemic risks – such as maturity transformation and leverage – arising from the shadow banking sector and its interaction with the regular banking system. The detailed recommendations that will be produced by the five workstreams during 2012 are thus fundamental to the stability of the global financial system.”