The Financial Stability Board (FSB) published the Global Shadow Banking Monitoring Report 2017, which presents the results of the FSB’s seventh annual monitoring exercise to assess global trends and risks from shadow banking activities. The 2017 monitoring exercise covers data up to end-2016 from 29 jurisdictions, which together represent over 80% of global GDP, including, for the first time, Luxembourg. Also for the first time, the report assesses the involvement of non-bank financial entities in China in credit intermediation that may pose financial stability risks from shadow banking, such as maturity/liquidity mismatches and leverage.
Main findings:
- The activity-based, narrow measure of shadow banking grew by 7.6% in 2016 to $45.2 trillion for the 29 jurisdictions. This represents 13% of total financial system assets of these jurisdictions. China contributed $7.0 trillion to the narrow measure (15.5%), and Luxembourg $3.2 trillion (7.2%).
- Collective investment vehicles with features that make them susceptible to runs (eg open-ended fixed income funds, credit hedge funds and money market funds), which represent 72% of the narrow measure, grew by 11% in 2016. The considerable trend growth of these collective investment vehicles – 13% on average over the past five years – has been accompanied by a relatively high degree of investment in credit products and some liquidity and maturity transformation. This highlights the importance of implementing the FSB policy recommendations on structural vulnerabilities from asset management activities published in January 2017.
- The assets of market intermediaries that depend on short-term funding or secured funding of client assets (eg broker-dealers) declined by 3%. These intermediaries accounted for 8% of the narrow measure by end-2016. Reflecting their business models, broker-dealers in some jurisdictions employ significant leverage, although it is lower than the levels prior to the 2007-09 global financial crisis.
- The assets of non-bank financial entities engaged in loan provision that is dependent on short-term funding, such as finance companies, shrank by almost 4% in 2016, to 6% of the narrow measure. In some jurisdictions, finance companies tend to have relatively high leverage and maturity transformation, which increases their susceptibility to roll-over risk during period of market stress.
- In 2016, the wider “Other Financial Intermediaries” (OFIs) aggregate, which includes all financial institutions that are not central banks, banks, insurance corporations, pension funds, public financial institutions or financial auxiliaries, grew by 8% to $99 trillion in 21 jurisdictions and the euro area, faster than banks, insurance corporations and pension funds. OFI assets now represent 30% of total financial assets, the highest level since at least 2002.
The 2017 monitoring exercise also benefited from improved data submissions by authorities to measure interconnectedness among financial sectors and to assess short-term wholesale funding trends, including repurchase agreements (repos). On an aggregated basis, both banks’ credit exposures to, and funding from, OFIs have continued to decline in 2016, and are at 2003-06 levels.
The global monitoring of developments in the shadow banking system is part of the FSB’s strategy to transform shadow banking into resilient market-based finance. The monitoring exercise adopts an activity-based approach, focusing on those parts of the non-bank financial sector that perform economic functions which may give rise to financial stability risks from shadow banking. The FSB defines “shadow banking” broadly as “credit intermediation involving entities and activities (fully or partially) outside the regular banking system”. Such intermediation, appropriately conducted, provides a valuable alternative to bank funding that supports real economic activity.
But experience from the 2007-09 financial crisis demonstrates the capacity for some non-bank entities and transactions to operate on a large scale in ways that create bank-like risks to financial stability (longer-term credit extension based on short-term funding and leverage). Such risk creation may take place at an entity level but it can also form part of a chain of transactions, in which leverage and maturity transformation occur in stages, and in ways that create multiple forms of feedback into the regular banking system.