The booming non-bank financial industry has created excessive leverage that poses financial stability risks, and more reforms are needed to tackle it, including improving disclosure of positions, a Bank of England regulator said on Thursday.
Non-bank financial institutions (NBFIs), including hedge funds, private credit providers and insurers, have become increasingly important.
They accounted for $218 trillion, or just under half, of the world’s financial assets in 2022, according to the G20’s Financial Stability Board.
The Bank of England estimates that half of the funding for UK businesses now comes directly from financial markets and non-banks, rather than traditional bank loans.
The so-called “shadow banking” sector’s rapid expansion is a growing priority for regulators, who worry about its lack of transparency and the degree to which its problems could threaten the stability of financial markets.
“While recent international reforms since the March 2020 ‘dash for cash’ have addressed some NBFI risks, such as in liquidity mismatch of money market funds, excessive NBFI leverage still poses financial stability risks,” Nathanaël Benjamin, executive director for financial stability strategy and risk, said in a speech published online.
Benjamin said these risks were especially worrying when funding positions were concentrated in areas of core markets such as government bonds, and when these positions are used in common strategies across non-banks or highly concentrated among a small number of non-banks.
“At the same time, enhancing transparency around ‘hidden’ leverage through improved disclosures by NBFIs to their counterparties and regulators can help identify concentrations and correlations in key markets, allowing risks to be addressed,” he said.
The G20 financial watchdog later this year plans to reveal the findings of a massive exercise to gather data on non-banks and their ties to regulated lenders. The BoE is seeking to build a case for new rules based on findings from its first sector-wide stress test.
The growth of non-banks in the last 15 years has increased the use of collateral in the financial system, bringing benefits but at the same time new challenges, Benjamin said, including the increased liquidity demands made on participants when margin calls spike during times of market stress.
As examples of episodes of market stress, he cited the impact of Russia’s invasion on Ukraine on natural gas prices, and the near implosion of the liability driven investment industry in Britain in 2022.
(Reporting by Tommy Reggiori Wilkes; editing by Sinead Cruise and Mark Potter)
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