FSB Explains Work To Be Done On Shadow Banking

by Ulrika Lomas, LawAndTax-News.com, Brussels

06 September 2011

Following the meeting in Paris on July 18 this year of the Financial Stability Board (FSB), where initial recommendations were approved for strengthening oversight of the shadow banking system, its Task Force on Shadow Banking has identified five areas where more detailed work is warranted to help gauge the case for further regulatory action.

The shadow banking system refers to activities by credit intermediaries not subject previously to regulation, primarily because they do not accept traditional bank deposits. As a result, many such institutions and the instruments they issue are able to incorporate higher market, credit and liquidity risks, and may not have capital requirements commensurate with those risks.

Their ranks include finance companies, asset-backed commercial paper conduits, structured investment vehicles, credit hedge funds, money market mutual funds and securities lenders, intermediating credit through a wide range of securitization and secured funding techniques, such as credit default swaps, asset-backed securities and collateralized debt obligations.

Following an assessment of the broad scale and trends of non-bank credit intermediation in the financial system, financial authorities will narrow down their focus to those activities which have the potential to pose systemic risks, by focusing in particular on those involving maturity transformation, liquidity transformation, imperfect credit risk transfer and/or leverage.

The Task Force confirmed that it has since conducted a further data and information sharing exercise during the summer as a step toward evaluating and adjusting the proposed framework, and has identified five areas where more detailed work is warranted to help gauge the case for further regulatory action.

Those areas include the regulation of banks’ interactions with shadow banking entities, in particular examining consolidation rules for prudential purposes, limits on the size and nature of a bank’s exposures to shadow banking entities, risk-based capital requirements for banks’ exposures to shadow banking entities, and treatment of implicit support; the regulatory reform of money market funds; and the regulation of other shadow banking entities.

In addition, the FSB will look further into the regulation of securitization, in particular with regard to retention requirements and transparency; and the regulation of activities related to securities lending/repos, including possible measures on margins and haircuts.

In order to make progress, the FSB has decided to set up dedicated work-streams to focus on each area. In some cases, the work-streams will be undertaken by the relevant international standard-setting bodies, while in others work will be carried forward under the guidance of the FSB Task Force.

The work-streams will develop preliminary work plans shortly, and report their progress as well as the proposed policy recommendations to the FSB by July 2012 (or end-2012 for securities lending/repos).

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