Forum Post: FSB seeks to tame shadow banking

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Non-bank lending markets face unprecedented levels of government intervention under sweeping new proposals to tame “shadow banking” laid out by global regulators meeting as the Financial Stability Board.

The Basel-based regulatory group made clear on Sunday that it intends to push for tighter oversight of any part of the $67tn sector that takes on bank-like attributes such as using short-term assets to fund longer-term lending, known as “maturity transformation”. They also intend to set global capital and liquidity standards for non-banks that could be subject to investor panics akin to a depositor run.

“If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards,” Lord Turner, the UK regulator who helped lead the project, told the Financial Times.

In a shift in tone from early discussions of shadow banking, the FSB was careful to say that some shadow banking, which includes all private financial institutions that are not banks, insurers or pension funds, provides much needed funds to the real economy.

The wide-ranging package includes new rules for everything from asset securitisation to short-term lending, as well as guidelines for regulators around the world on how to distinguish potentially dangerous innovations from garden variety “market finance”.

Among the most controversial proposals are plans to set minimum discounts known as “haircuts” for secured lending in the “repo” markets. The FSB has also proposed tighter rules on “rehypothecation”, which occurs when a custodian or broker takes the assets they are supposed to be holding and lends them out to someone else.

“Anybody with a securities portfolio can build a shadow bank by lending it out for cash and using the cash to make loans ... so the regulatory community as a whole wants to consult on whether we should put floors on haircuts or at least have official guidelines on how to determine haircuts,” said Paul Tucker, Bank of England official and an FSB member, who has suggested that minimum haircuts could tamp down asset bubbles.

The board also called for tighter capital and liquidity requirements for money market funds that maintain a bank-like constant net asset value. The US industry has fought hard to fend off such restrictions but senior regulators said last week they intended to press forward.

The FSB’s report has been hotly anticipated since the leaders of the Group of 20 nations asked the board in 2011 to suggest ways to prevent the banking industry from using shadow banking to circumvent global efforts to make lenders safer. The politicians were particularly worried that the same excessive borrowing and asset price swings seen in the 2008 financial crisis could recur in less regulated sectors.

“We have clearly created incentives for people to do maturity transformation outside the banking system. We need to be constructing a regulatory and supervisory regime that guards against shadow banking creating the crisis of 2015 or 2020,” Lord Turner said.