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FSB: Shadow banking now accounts for almost half the world's financial assets

Shadow banking grew for the sixth consecutive year in 2017, to $184.3 trillion, to account for almost half of total global financial assets, according to the Financial Stability Board.

In its latest report on the sector, published on Feb. 4, the FSB said the broadest measure of shadow banking, including insurance corporations and pension funds, grew at 7%. The report, the FSB's eighth, covers 29 jurisdictions which together represent about 80% of world economic output.

Shadow banking is the term used to cover non-bank financial intermediaries that act like banks by lending to corporations or households but that are not regulated like banks, though many are subject to different forms of regulation. In addition to insurance companies and pension funds, the term covers hedge funds, asset management companies, peer-to-peer lending websites and bond trading, for instance.

Systemic risk

The FSB, which is funded by the Bank for International Settlements and set up to improve global financial robustness after the financial crisis, previously referred to non-bank financial intermediation as "shadow banking" but switched terms in October 2018.

While the FSB said such activity could be beneficial to corporations and households, it also warned of the potential dangers in the growth of shadow banking as a source of systemic risk, particularly if it involves activities usually carried out by banks, like creating leverage.

Global financial assets stood at $382.3 trillion in 2017, so at $184.3 trillion shadow banking accounted for 48.2% of the total, said the FSB.

Within this broadest definition of shadow banking, the FSB said the next biggest group of financial institutions, mainly investment funds, that are not banks, insurance firms, or pension funds, grew by 7.6% to reach $116.6 trillion in assets.

This is more than twice as fast as banks, defined as deposit-taking corporations, which grew at 2.8%. Banks' growth rate was the slowest rate of all major financial sectors.

Since 2008, banks' share of total global financial assets has declined to 39% from 45%, as other financial intermediaries have taken on a larger share, increasing to 31% from 26%. This trend, said the FSB, has been more pronounced in China and the euro area.

Structured finance vehicles' assets grew slightly in 2017 to $4.9 trillion for the first time since the financial crisis, including in Italy, Luxembourg, the Cayman Islands, China and India, though there was a sharp decline in SFV assets in the U.S. Such entities played a key role in the financial crisis through their investment in sub-prime mortgage-backed bonds and collateralized debt obligations.

Those institutions that came under the FSB's "narrow" definition of shadow banking include entities, like credit hedge funds and open-ended fixed-income funds, whose actions can result in bank-like stability risks, showed growth of 8.5% to reach $51.6 trillion in assets. The FSB warned some of these funds were susceptible to "run" risk.

The Cayman Islands, China, Ireland and Luxembourg together accounted for more than two-thirds of the increase in this "narrow" measure, which was slightly below the 2011-16 growth rate of 8.8%.

Non-bank finance companies providing loans based on short-term funding grew by 6%, while market intermediaries, mostly broker-dealers, grew by 5%. The FSB noted that some broker-dealers continued to employ significant leverage, though it is lower than the level seen before the financial crisis.

Interconnectedness

Banks and such organizations have become marginally more interconnected through credit and funding relationships, said the FSB, though this remains at around the levels found in 2003-2006.

This interconnectedness with the banking system is a key concern of the FSB, particularly if it involves activities by financial institutions that are typically performed by banks, like borrowing money on a shorter timeframe than it is lent. The FSB said such interconnectedness could increase if, for example, investment funds invest in fintech products while banks underwrite fintech loans.

"Non-banks play a growing role in the financial system, and their share of the financial system is the largest on record," said Klaas Knot, the chair of the FSB standing committee on assessment of vulnerabilities.

"They are becoming important players in areas where banks traditionally have played dominant roles. Authorities need to remain vigilant in addressing financial stability risks that emerge as a result of non-bank financing through enhanced data collection, improved risk analysis and implementing appropriate policy measures, including the FSB's policy recommendations for addressing structural vulnerabilities from asset management activities."

The FSB's annual monitoring exercise is aimed at assessing global trends and risks in shadow banking and identifying financial entities or activities that might lead to a review of existing regulation.