Regulators outline controls on shadow banking industry

Proposed regulation would cover property entities such as debt funds

The Financial Stability Board is pushing for tighter monitoring and regulation of the $67trn shadow banking industry, the lending and credit provided by financial institutions that are not banks, insurers or pension funds.

This includes investment funds, exchange-traded funds, finance houses and structured finance vehicles such as those used in securitisation, all of which feature in the commercial real estate markets.

For example, the debt funds that are being set up to lend to commercial real estate would be considered shadow bankers. The US shadow banking system is the largest, at $23trn in 2011, followed by the euro area ($22trn) and the UK ($9trn).

The FSB, a global group of regulators and central bankers, said these non-bank channels can risk destabilising financial systems, “especially when they are structured to perform bank- like functions and are strongly interconnected with the regular banking system”.

It has published a consultative paper, outlining policy for regulating shadow banks. It included specific recommendations on money market funds and other entities the FSB says should be identified  on the basis of their economic functions, and outlines a policy toolkit regulators can use to address various shadow banking activities.

The five economic functions identified are:

  • Management of client cash pools with features making them susceptible to runs, such as credit investment funds and leveraged credit hedge funds;
  • Loan provision dependent on short-term funding e.g. finance companies with short-term funding structures or that take deposits;
  • Intermediation of market activities dependent on short- term funding or secured funding of client assets e.g. securities brokers whose funding heavily depends on wholesale funding;
  • Facilitation of credit creation e.g. credit insurers;
  • Securitisation and funding of financial entities such as securitisation vehicles.

The FSB wants better disclosure by securitisation issuers – for example, of their stress testing of assets – and more standardisation, such as templates for asset information.