The Financial Stability Board, an international body established by the G20 to monitor and make recommendations on the international financial system, released a new report on how to better oversee the shadow banking system so it does not pose a global systemic risk. The shadow banking system is represented by non-depository institutions such as hedge funds, private-equity groups, and money-market funds that typically have less regulation and transparency. The report spells out how to better monitor the industry, notes what new rules may be needed to provide sufficient oversight, and lists the potential risks that are posed by it.
An excerpt:
As the financial crisis has shown, the shadow banking system can also become a source of systemic risk, both directly and through its interconnectedness with the regular banking system. Short-term deposit-like funding of non-bank entities can lead to “runs” in the market if confidence is lost. The use of non-deposit sources of collateralised funding can also facilitate high leverage, especially when asset prices are buoyant and margins/haircuts on secured financing are low. Moreover, the risks in the shadow banking system can easily spill over into the regular banking system as banks often comprise part of the shadow banking credit intermediation chain or provide support to shadow banking entities. These risks are amplified as the chain becomes longer and less transparent.
