Thursday, May 26, 2016

FSB Review Concludes that Taming of Shadow Banking is Far From Complete

Encourages Member States to Continue Their Efforts

Author: David Schwartz J.D. CPA

According to a peer review published the by Financial Stability Board (FSB) on May 25, 2016, regulation of shadow banking remains at an early stage, and much progress remains to be made. According to the report, notwithstanding the progress made, “more work is needed to ensure that jurisdictions can comprehensively assess and respond to potential shadow banking risks posed by non-bank financial entities, and support FSB risk assessments and policy discussion.”


The FSB defines “shadow banking system” broadly as “credit intermediation involving entities and activities (fully or partially) outside the regular banking system,” or non-bank credit intermediation in short. Appropriately conducted, non-bank credit intermediation provides a valuable alternative to bank funding that supports real economic activity. But experience from the crisis demonstrates the capacity for some non-bank entities and activities to give rise to bank-like risks to financial stability (longer-term credit extension based on short-term funding and leverage). To address these risks, and to build more sustainable sources of non-bank financing for the real economy, the FSB has been working on transforming shadow banking into resilient market-based finance as a core element of regulatory reforms. The purpose of the May 25, 2016 peer review was to assess the progress made by FSB member jurisdictions in implementing the regulatory principles set forth in the FSB’s August 29, 2013 Policy Framework for Strengthening Oversight and Regulation of Shadow Banking Entities (“Policy Framework”), which is a key component of the FSB’s efforts in this area. 


The peer review revealed a number of interesting findings about the state of shadow banking regulatory reform, highlighting both successes and weaknesses:


  • Most non-bank financial entities fall within the regulatory perimeter, and there is a broad range of institutional arrangements for their regulation and supervision. Investment funds represent the majority of the assets of entities covered by the information-sharing exercise, and have experienced the fastest growth in recent years. This underscores the growing importance that securities regulators play in promoting financial stability.
  • Most jurisdictions classified non-bank financial entities into the five economic functions broadly in line with the Policy Framework,1 but there are some differences and inconsistencies in the classification and assessment of risks based on those functions.
  • Reviews of the regulatory perimeter in most jurisdictions appear to be ad hoc and undertaken in response to concerns arising about a particular activity or entity type.
  • Data from existing reporting and disclosure arrangements for non-bank financial entities were not usually designed for collecting shadow banking-specific information, so they may not be adequate or sufficiently granular to assess related risks.
  • It is unclear whether disclosure requirements for non-bank financial entities and reports published by authorities (e.g. financial stability reviews) enable market participants to adequately assess shadow banking risks posed by these entities. Few jurisdictions report planning reviews that could enhance those disclosures.
  • Jurisdictions report a range of policy tools to address shadow banking risks posed by non-bank financial entities. Some of these tools, especially for investment funds, are discretionary in nature.2 Most jurisdictions report no initiatives to change their toolkit.


The peer review encourages FSB jurisdictions to continue efforts to implement the Policy Framework, and makes a number of recommendations and suggestions:


  • Establish a systematic process involving all relevant domestic authorities to assess the shadow banking risks posed by non-bank financial entities or activities;
  • Address data gaps to be able to better assess the potential financial stability risks posed by non-bank financial entities or activities;
  • Remove impediments to cooperation and information-sharing between authorities, including on a cross-border basis; and
  • Review and enhance public disclosures by non-bank financial entities as necessary to help market participants understand the shadow banking risks posed by such entities.


The peer review indicates that the FSB still considers shadow banking to be an avenue of considerable risk to the global financial system.  The authors said that, going forward, the FSB will conduct follow-up work to: enhance consistency across jurisdictions in their classification of non-bank financial entities into economic functions; develop approaches to help jurisdictions better monitor and assess risks from those entities’ interconnectedness and cross-border activities; and facilitate the sharing of information among member authorities on policy tools and public disclosures.  The FSB expects to issue further peer reviews to update progress on implementation of the Policy Framework.