FSB Calls for New Curbs on Shadow Bank Companies

The Financial Stability Board, a global financial watchdog, is calling for greater oversight of the multitrillion-dollar shadow banking sector.

The FSB issued a report Wednesday (July 9) on the growth of nonbank financial institutions (NFBIs), saying that regulators should consider limits on leverage used by these firms while also taking steps to limit their size, according to a Wednesday press release.

“Leverage recommendations give authorities flexibility to select, design and calibrate measures that best address financial stability risks created by NBFI leverage in their jurisdiction, while considering potential adverse effects,” the release said.

NFBIs include private credit and private equity firms, insurers and hedge funds. These groups hold $218 trillion, or nearly half of the world’s financial assets, Reuters reported Wednesday.

“The capital flows that connect banks, private credit firms, FinTechs and the latter’s end customers [are] interwoven, with risks and rewards extending across that continuum,” PYMNTS wrote in May.

Research from the Federal Reserve Bank of Boston found that banks have been increasing their exposure to NBFIs. Large banks’ total loan commitments to private credit and private equity funds in 2023 were approximately $300 billion, or 14% of large banks’ total lending to NBFIs. The tally was less than $10 billion a decade earlier.

The Boston Fed contended that “understanding the scale and complexity of bank-NBFI connections is important for identifying potential risks to financial stability — that is, the financial system’s ability to continue supplying capital to the economy if strained by shocks.”

Amid this backdrop, the FSB and other regulators have warned about the lack of transparency in the sector and the fact that problems among these groups could harm the larger financial markets.

“Importantly, there is a clear public policy case to strengthen the regulation of nonbank providers of financial services by introducing entity-specific requirements aimed at addressing the concrete risk they pose for the financial system,” Fernando Restoy, chairman of the Financial Stability Institute, said in a speech in May at an industry conference on financial sector stability in times of macro stress.

While Restoy cautioned against “blindly” applying banking regulations to NBFIs, he said that “there hasn’t been sufficient policy action to introduce entity-based requirements addressing the specific risks posed by entities — such as Big Tech firms — that uniquely combine the provision of a wide array of financial and non-financial services using shared data and technological infrastructure.”