Securities lending is a potentially pro-cyclical source of funding, raising the possibility that participants will have to dump securities during times of financial stress.  It can lead to unexpected connections among disparate market players, such as insurance companies and hedge funds.  As a result, securities lending may contribute to the opacity of the financial system and erode the willingness of participants to take on counterparty risk.  In addition, it is a source of contagion, with the distress of one firm ramifying throughout the financial system in unpredictable ways.

The Financial Stability Oversight Council, Financial Stability Board, and Securities and Exchange Commission still fear the systematic risks posed by potential runs on money market funds. Seeing money funds as unfinished business from the 2008 financial crisis, the FSOC and FSB have floated some fairly serious structural changes to that industry. It is not clear, however, that the cures they propose are not potentially more systematically risky than the status quo.  SEC Commissioner, Luis Aguilar, typically a champion of more regulation designed to protect investors, has raised the alarm regarding a potential unintended consequence of additional money market reforms.  It is Aguilar who threw the spanner in the in the plans of former SEC Chairman, Mary Schapiro, to propose a slate of structural regulations for money market funds. He did so over this very issue. Aguilar worries that money fund assets will migrate to an opaque, unregulated market as a result of structural changes to money market funds.  He feels that the earlier rounds of regulatory reform for money market funds were a resounding success, making money market funds one of the most transparent financial instruments for both regulators and investors.  Further reform proposals, however, could steer funds into markets that are not as open to the SEC, ultimately making them less regulated.

Appropriate monitoring and regulatory frameworks for the shadow banking system needs to be in place to mitigate the build-up of risks.

On November 18, 2012, the Financial Stability Board (FSB) published for public consultation an initial integrated set of policy recommendations intended to strengthen oversight and regulation of shadow banking. Given the FSB's finding that the shadow banking system grew to a new high of $67 trillion globally last year, it is understandable that regulators and policy-makers, including those among the FSB's membership, fear that shadow banking activities harbor serious and sometimes hidden risks to the global financial system.  The FSB's November 18 release calls for greater controls on this area of the financial world that has thus far escaped explicit regulation.  The consultation paper is timely given the European Commission is poised to propose EU-wide shadow banking rules in 2013, and the US Treasury Department has recently proposed structural changes to money market funds, considered a key part of the shadow banking system, to combat the perceived systematic risks posed by them.