The Financial Stability Board (FSB), which was "established to coordinate at the international level the work of national financial authorities and international standard setting bodies and to develop and promote the implementation of effective regulatory, supervisory and other financial sector policies in the interest of financial stability," published "an initial integrated set of policy recommendations to strengthen oversight and regulation of the shadow banking system. The documents include "An Integrated Overview of Policy Recommendations; a Policy Framework for Strengthening Oversight and Regulation of Shadow Banking Entities; and Policy Recommendations to Address Shadow Banking Risks in Securities Lending and Repos. The FSB also issued a Global Shadow Banking Monitoring Report 2012 "analysing recent trends and risks in the shadow banking system," says a statement.
The FSB's Overview says, "The Financial Stability Board (FSB) is seeking comments on consultative documents on Strengthening Oversight and Regulation of Shadow Banking. The FSB has focused on five specific areas in which the FSB believes policies are needed to mitigate the potential systemic risks associated with shadow banking: (i) to mitigate the spill-over effect between the regular banking system and the shadow banking system; (ii) to reduce the susceptibility of money market funds (MMFs) to "runs"; (iii) to assess and mitigate systemic risks posed by other shadow banking entities; (iv) to assess and align the incentives associated with securitisation; and (v) to dampen risks and pro-cyclical incentives associated with secured financing contracts such as repos, and securities lending that may exacerbate funding strains in times of "runs"."
The FSC says, "The "shadow banking system" can broadly be described as "credit intermediation involving entities and activities (fully or partially) outside the regular banking system" or non-bank credit intermediation in short. Such intermediation, appropriately conducted, provides a valuable alternative to bank funding that supports real economic activity. But experience from the 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 complex chain of transactions, in which leverage and maturity transformation occur in stages, and in ways that create multiple forms of feedback into the regulated banking system."
It continues, "Like banks, a leveraged and maturity-transforming shadow banking system can be vulnerable to "runs" and generate contagion risk, thereby amplifying systemic risk. Such activity, if unattended, can also heighten procyclicality by accelerating credit supply and asset price increases during surges in confidence, while making precipitate falls in asset prices and credit more likely by creating credit channels vulnerable to sudden losses of confidence. These effects were powerfully revealed in 2007-09 in the dislocation of asset-backed commercial paper (ABCP) markets, the failure of an originate-to-distribute model employing structured investment vehicles (SIVs) and conduits, "runs" on MMFs and a sudden reappraisal of the terms on which securities lending and repos were conducted. But whereas banks are subject to a well-developed system of prudential regulation and other safeguards, the shadow banking system is typically subject to less stringent, or no, oversight arrangements."
The Policy Framework explains, "The objective of the FSB's work is to ensure that shadow banking is subject to appropriate oversight and regulation to address bank-like risks to financial stability emerging outside the regular banking system while not inhibiting sustainable non-bank financing models that do not pose such risks. The approach is designed to be proportionate to financial stability risks, focusing on those activities that are material to the system, using as a starting point those that were a source of problems during the crisis. It also provides a process for monitoring the shadow banking system so that any rapidly growing new activities that pose bank-like risks can be identified early and, where needed, those risks addressed. At the same time, given the interconnectedness of markets and the strong adaptive capacity of the shadow banking system, the FSB believes that proposals in this area necessarily have to be comprehensive."
The document adds, "Policy recommendations for MMFs are have been developed by a separate FSB shadow banking workstream (WS2) led by IOSCO. See http://www.iosco.org/library/pubdocs/pdf/IOSCOPD392.pdf."
The FSC Repo document comments, "Based on the initial recommendations to strengthen oversight and regulation of the shadow banking system as set out in its report submitted to the G20 in October 20114, the Financial Stability Board (FSB) set up the Workstream on Securities Lending and Repos (WS5) to assess financial stability risks and develop policy recommendations, where necessary, by the end of 2012 to strengthen regulation of securities lending and repos. In April 2012, WS5 published its interim report Securities Lending and Repos: Market Overview and Financial Stability Issues which provided an overview of the securities lending and repos markets, described their location in the shadow banking system, and discussed the financial stability issues arising from practices in these markets. Comment letters were received from 17 respondents including trade associations representing both securities borrowers and lenders, intermediaries in the securities lending and repo markets, and asset managers. In general, the respondents supported the FSB's efforts to address risks that are inherent in the securities lending and repo markets, but asked for care in weighing the pros and cons as well as assessing the potential impact of any policy measures that might be introduced and existing regulations that may mitigate potential financial stability concerns."
They add, "In developing its policy recommendations, WS5's focus was on addressing the financial stability issues as described in Section 1. They are based on issues discussed in the interim report but with more focus on shadow banking risks so as to have a clear mapping to policy recommendations. WS5 has endeavoured to ensure that its recommendations minimise the risk of regulatory arbitrage as well as undue distortion of markets, and are consistent with other international regulatory initiatives."
The Overview adds, "The FSB welcomes comments on these documents. Comments should be submitted by 14 January 2013 by email to fsb@bis.org or post (Secretariat of the Financial Stability Board, c/o Bank for International Settlements, CH-4002, Basel, Switzerland). All comments will be published on the FSB website unless a commenter specifically requests confidential treatment. The FSB expects to publish final recommendations in September 2013.
