Definition of Shadow Banking
The complexity, the extensive range of activities, and the lack of transparency of the shadow banking system make it difficult to formulate a single all-encompassing definition. Some authors define shadow banking by reference to particular instruments and entities. According to Gordon and Metrick, for example:
In its broad definition, shadow banking includes such familiar institutions as investments banks, money market mutual funds, and mortgage brokers; some rather old contractual forms, such as sale-and-repurchase agreements (repos); and more esoteric instruments such as asset-backed securities (ABSs), collateralized debt obligations (CDOs) and asset backed commercial paper (ABCP). (Gorton and Metrick 2010).
Other authors define shadow banking by reference to entities performing credit intermediation so long as these entities are non-bank entities. The earlier and most famous entity-based definition was coined by McCulley who defined the shadow banking system as “the whole alphabet soup of levered-up non bank investment conduits, vehicles, and structures” (McCulley 2007).
Shadow banking is also defined by reference to entities and activities. The FSB (Financial Stability Board), for example, adopts a broad definition of shadow banking as “credit intermediation involving entities and activities (fully or partially) outside the regular banking system” (FSB 2017). Credit intermediation, in turn, consists of:
Maturity transformation that is converting long-term financial assets into short-term liabilities. Securitisation, which is considered “the central artery of the shadow banking system” (Gerding 2012), is fundamental to transform illiquid loans into liquid securities (short-term financial instruments for investors).
Credit transformation that consists in the enhancement of the credit quality of the debt issued by the intermediary and it is carried out, for example, by lending to borrowers with a lower credit standing (and thus a higher yield) than the intermediary funding instruments. Securitisation and derivatives play an important role in the credit transformation process (Gerding et al. 2012).
Liquidity transformation that consists in using liquid liabilities (short-term instruments) to fund illiquid assets.
The IMF introduces a further definition of shadow banking based on “non core liabilities” (IMF 2014). Non-core liabilities are defined in contrast to “core liabilities” that represent the traditional financial intermediation function of the banking system (viz. regular deposits of ultimate creditors). According to this definition,
financing of banks and non bank financial institutions through non core liabilities constitutes shadow banking, regardless of the entity that carries it out. (IMF 2014)48
Because this definition focuses on the funding sources and not on the type of institution that issues the liabilities, it includes also forms of shadow banking that are carried out within the banking system.
Examples of shadow banking entities usually include, among others, money market funds (MMFs), credit hedge funds, broker-dealers, securities finance companies, credit insurance companies, and securitisation vehicles (FSB 2018). However, a list of shadow banking institutions could not be exhaustive, given the different forms that shadow banking may take across countries (due to different legal and regulatory framework) and the constant innovation of the sector. The instruments usually connected with shadow banking are asset-backed commercial papers, asset-backed securities, credit derivatives, CDO, and repos (Gorton and Metrick 2010; Gerding 2012).
Despite the differences, the various definitions do underline some typical characteristics of the shadow banking system that is to provide credit intermediation services linking borrowers to investors through capital markets. Therefore, shadow banking performs a role similar to traditional banks but it relies on financial markets not on bank deposits for the provision of funds. Shadow banks raise short-term funds in the money market and use those funds to buy assets with longer term maturities. However, unlike the traditional banking system, the credit intermediation process is conducted through a chain of non-bank financial intermediaries linked together in complex ways. As we have already said, securitisation and credit derivatives represent an important component of the shadow banking system.49 The shadow banking system, being outside or partially outside the banking system, is not subject to traditional bank regulation. Therefore, shadow banks do not have access to central bank refinancing and deposit guarantee schemes. However, the financing sources (short-term liabilities) on which the system relies, according to many scholars (e.g. Gorton, Gerding, Kane, and Ricks), are functionally equivalent to bank deposits. Some shadow banking instruments have money-like characteristics (low risk and high liquidity) and can thus be subject to runs and panics whenever confidence is lost as the 2008 financial crisis highlighted. As is widely acknowledged, many of the events that marked the crisis were related to non-bank financial institutions and markets.
Recent Evolution of Shadow Banking
The sector of shadow banking has grown massively in the years before the crisis: according to the FSB (2012), assets in the global shadow banking system grew from $26 trillion in 2002 to $62 trillion in 2007.50
The literature mentions many factors as key drivers of this exceptional growth. Deregulation and competition, for example, encouraged commercial banks to enter high-risk businesses. Increased competition from non-bank and innovation in financial markets, helped by regulatory and legal changes (in particular the special treatment under the bankruptcy code for repos and securitisation), contributed to the decline of the traditional banking sector (Gorton and Metrick 2010). Some authors explain growth as fuelled by regulatory arbitrage and technology (e.g. Schwarz 2011–2012): banks tried to circumvent capital requirements shifting activities to the non-bank sector, while technology has provided non-bank financial institutions to cope with investors demand for products quickly and at a lower cost than the traditional banks.
Non-bank intermediation in itself, according to most authors, does have advantages in terms of creating new sources of funding, reducing reliance on banks and therefore bringing diversity to the financial system; however, to the extent that non-bank intermediaries perform a bank-like function and are largely unregulated, they can become a source of systemic risk. In fact, the 2008 financial crisis has shown that shadow banking poses the same, if not higher, economic risks and negative externalities as traditional banks. In addition, shadow banking is not a standalone system but it is deeply interconnected with the core banking system in a complex way. The two systems are interconnected, for example, through markets such as repo market that links MMFs, banks, investment banks, hedge funds through securities lending. As stated by the FSB (2017)
The financial crisis revealed how the regular banking system was both intertwined with and exposed to risk in the shadow banking system. For example, shadow banking often involves explicit or implicit support from banks, which “borrow trust” from the capital and liquidity resources of banks, and ultimately, banks’ backstop mechanisms. Before the crisis, this support allowed shadow banking entities to expand and transform liquidity/maturity on a scale they would otherwise not have been able to do.
In the United States, the creation of “financial holding companies”, following the dismantling of the Glass-Steagall Act and the passage of the Gramm-Leach-Bliley Act of 1999, facilitated this process. Conglomerates that own or control commercial banks, investment banks, insurer companies, and other financial institutions enable the transfer of public subsidy meant for banks to other affiliates in the corporate group. According to Hockett and Omarova (2016), “the most critical overall benefit that non-bank financial institutions derive from affiliating with commercial banks is access to banks’ deposit base.”
The Federal Reserve emergency lending facilities introduced in the aftermath of the Lehman Brothers’ bankruptcy were a recognition of the necessity to provide a backstop for all the functional steps involved in the shadow banking process (Porzan et al. 2010).
During the decade following the financial crisis, policymakers and regulators have been implementing legislative reforms based on the principles set by the G20 countries which charged the FSB with the task of fixing the fault lines that caused the financial crisis in conjunction with international standard setters and organisations. In particular, regarding the shadow banking system, the G20 Summit (2011) acknowledged that “The shadow banking system can create opportunities for regulatory arbitrage and cause the build-up of systemic risks outside the scope of the regulated banking sector” (G20, Final Declaration, 2011). Therefore, the G20 countries agreed to strengthen the regulation and oversight of the shadow banking system through a “balanced approach between indirect regulation of shadow banking through banks and direct regulation of shadow banking activities, including money market funds, securitisation, securities lending and repo activities and other shadow banking entities” (ibidem). To this end, they requested the FSB to develop a series of reforms and policy measures to transform shadow banking into resilient market-based finance. Following this mandate, the FSB focused on five specific areas where action should have been taken to reduce systemic risk: (1) mitigating risks in banks’ interactions with shadow banking entities, (2) reducing the susceptibility of MMFs to “runs”, (3) improving transparency and aligning incentives in securitisation, (4) dampening pro-cyclicality and other financial stability risks in securities financing transactions (SFTs) such as repos and securities lending, and (5) assessing and mitigating financial stability risks posed by other shadow banking entities and activities (FSB 2013).
Regulators around the world tried to monitor shadow banking and create new rules addressing both shadow banking as entities and the instruments of shadow banking. The entity-based regulation can be carried on through the regulation of shadow banks operations (direct regulation) and through the regulation of banks’ interaction with shadow banking entities (indirect regulation).
Following this categorisation, in the next sections, I analyse the main points of the implemented regulation in the United States and EU.
The Post-crisis Regulation of Shadow Banking in the United States
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (see Appendix 1 in Vercelli 2017) included many provisions relevant to shadow banking. Indirect regulation tried to address shadow banks’ failures by
implementing increases in banks’ capital requirement,
designating important financial institution to be under increased regulation and scrutiny,
separating risky proprietary trading from the core banking system.
Specifically, as for point 1, the “Collins Amendment” to Dodd-Frank (Section 171) amended the definition of capital and imposed capital and leverage requirements to US depository institutions, US bank holding companies, bank subsidiaries, and systemically important non-bank financial companies. Subsequently, the above requirements were integrated with the adoption of Basel III international standards (see “The US Final Rule on capital standards” that adopted the Basel III framework on July 2013).
As for point 2, Dodd-Frank addressed the systemic risk associated with largest, most complex, and most interconnected financial institution by allowing the Financial Stability Oversight Council (FSOC) to designate systemically important financial institutions (banks and non-banks) that could pose a threat to financial stability in order to put them under increased regulatory scrutiny.
While banking organisations with $50 billion or more in assets were automatically subject to enhanced prudential standards, non-bank SIFIs were designated on a case-by-case basis.
On May 2018, the “Economic Growth, Regulatory Relief, and Consumer Protection Act” (the “Reform Law”, bill S.2155), the first major financial services reform bill since the enactment of the Dodd-Frank Act, was passed into law. The bill, among other things, has increased, from $50 billion to $250 billion, the threshold (amending Section 165 of the Dodd-Frank Act) at which a large banking organisation automatically becomes subject to enhanced federal oversight, including, for example, higher capital, liquidity, stress tests, and other requirements (Lexology 2018).
Banks with assets of less than $100 billion would be freed of current oversight requirements. The Federal Reserve has been granted discretionary power to impose enhanced standards on organisation with $100 billion or more in assets. The alleged aim of the legislation was to give regulatory relief to smaller financial institutions and community banks and although there was a bipartisan consent on this point, the $250 million threshold raised concerns even among supporters of a revision. For example, former Representative Barney Frank, co-signatory of the original Dodd-Frank, said that the failure of two or three institutions in the $250 billion range would put the system in a “Lehman Brothers territory” (Vox, March 2018), considering that Countrywide Financial, for example, one of the largest home-mortgage providers, had assets in the $210 range before it failed (actually it was acquired by Bank of America for a sixth of the value of its market value before the crisis began).
As for non-bank SIFIs (investment banks and other non-banks), in the early years of Dodd-Frank enactment, FSOC designated Ge Capital (financial services unit of General Electric), AIG, Metlife, and Prudential (life insurers) as systemically important financial companies but by now none of them have SIFI label anymore. In fact, the Council de-designated GE Capital in 2016, AIG in 2017, Prudential in 2018, while Metlife won a legal battle to remove its designation in 2017. The designation process includes several rounds of investigation and research to make regulators understand how risk can affect the system. Dodd-Frank allowed designated companies to take actions to reduce risks and be re-examined for de-designation. Although the designated SIFIs undertook significant divestitures to reduce systemic risk, they remain large and globally connected companies (e.g. Metlife has 90 million consumers in 60 countries, AIG has half a trillion dollars in total assets), while two of them (GE Capital and AIG) were bailed out by the federal government during the 2008 financial crisis. Critics fear that the FSOC de-designation which effectively ended the entity-based non-bank SIFI regulation may have as consequence to incentivise the migration of risk from the regulated banking sector to the unregulated shadow banking system, a process that the post-crisis regulation was meant to prevent (Kress et al. 2018).
As for point 3, Dodd-Frank introduced the Volcker rule (Section 619) which prohibits BHCs from engaging as principal in proprietary trading for buying or selling financial instruments to profit from short-term price movements. It also prohibits banks from sponsoring or investing in hedge funds or private equity funds. The rule contains important statutory exemptions for certain activities such underwriting and market-making related activities, hedging, insurance company activities, as well as trading in US government securities and on behalf of customers. The rule took effect partially in July 2015. In 2018 the “Reform Law” exempted from the Volcker rule banks with less than $10 billion in total consolidated assets and in the same year the Federal Reserve approved a proposal which is currently under discussion, to “simplify and tailor compliance requirements related to the Volcker rule” (Federal Reserve 2018). The proposed reforms are meant to lighten some restrictions of the rule, for example giving banks more discretion to determine whether their trades are permitted, expanding exemptions and transferring some oversights to the banks themselves. However, some critics think that these reforms, once approved, would eliminate many protections included in the 2013 final rule. SEC Commissioner Kara Stein, for example, stated that “This proposal cleverly and carefully euthanizes the Volcker rule” (quoted in Gelzinis 2018).
An important piece of direct regulation is the regulation of MMFs.51 In the aftermath of the 2008 financial crisis which saw the oldest MMF in the United States (the Reserve Primary Fund) “break the buck”,52 the SEC (Securities and Exchange Commission) introduced significant rules changes for MMFs. In fact, in January 2010, the SEC adopted a first step of measures to strengthen both the resilience and stability of MMFs to avoid future risk of runs for the sector. The reforms were intended primarily to improve liquidity and credit risk management as well as to enhance reporting requirements. The 2010 rules, among other things, required MMFs to have a minimum percentage of their assets in highly liquid securities, limited MMFs investment in rated securities to those rated in the top two rated categories, permitted MMFs board of directors to suspend redemptions if the fund were about to “break the buck”. In 2014, the SEC introduced a new set of rules governing MMFs. The 2014 reforms required institutional prime MMFs (which invest primarily in corporate debt securities) and municipal MMFs (which invest primarily in tax-exempt municipal securities) to convert to a floating net asset value (FNAV).53 Retail MMFs and those investing in government securities were permitted to continue to adopt a constant net asset value (CNAV). The reforms also authorised both retail and institutional prime and municipal MMFs to impose liquidity fees under certain circumstances and suspend redemptions temporarily during times of stress (SEC 2014-143). Despite criticism regarding the likelihood that the FNAV would eliminate the risk of runs, the new rules “clarify for investors the risk associated with investing in money market mutual funds, while making it clear to the market and to policymakers that these financial instruments are not bank products to be overseen by prudential regulators, but rather investment products properly regulated by the SEC” (former SEC Commissioner Dan Gallagher as reported in the Consumer Financial Act And Capital Market Protection Act of 2017). As a result and in anticipation of these reforms, more than $1 trillion have shifted from prime and municipal MMFs with a FNAV to government MMFs with a CNAV by the end of 2016 (Rennison 2016). Concerns about rising borrowing costs in particular for municipal MMFs led in 2017 (May 3) to the introduction of a bill (H.R.2319) to reverse portions of the 2014 rules governing MMFs. The bill will restore the ability for all MMFs, regardless of whether their investors are retail or institutional to use a stable share price (CNAV) instead of a floating share price (FNAV) if they comply with certain requirements and restrictions. Additionally, the legislation removes the requirements for MMFs to impose liquidity fees. Although the bill prohibits a taxpayer bailout of any MMFs, it does not forbid the Federal Reserve to implement, under certain circumstances, a program of facilities that could benefit MMFs.
The bill was ordered reported on January 2018 by the House Financial Service Committee with strong bipartisan support (Stephen et al. 2018).
As we have seen, shadow banking can also be regulated through the regulation of its instruments as, for example, securitisation, repos, and derivatives. To promote an alignment of interests between sponsors and investors, the Dodd-Frank Act requires issuers of asset-backed securities (ABS) and any other entities who organise the sales of such securities to retain at least 5% of the credit risk of the securitised assets. To address the problem related to off-balance sheet vehicles, in June 2009 the Financial Accounting Standard Board issued two new accounting standards SFAS (Statement of Financial Accounting Standard) 166 and SFAS 167 resulting in firms consolidating some of their off-balance sheet securitised assets.
In particular, SFAS 166 eliminates the concept of “Qualified Special Purpose Entity” that allowed firms to transfer some financial assets off the balance sheet despite the fact that they retained effective control over those assets. As for derivatives, the Dodd-Frank Act contains significant chances in the regulation of OTC derivatives54 whereas the Act did not specifically target repos, which are affected indirectly by capital requirements set by the Act and Basel III.
To reform some aspect of the tri-party repo market55 which accounts for two-thirds of the US repo market, in February 2012 the Federal Reserve Bank of New York (FRBNY) issued a “Tri-party Repo Infrastructure Reform Task Force’s Final Report”. The Report laid out a road map to promote and recommend changes to the operational model of the then two clearing banks (custodian).56
A custodian plays a number of important roles as intermediary: when the two parties agree to enter into a tri-party repo transaction, they both independently instruct the custodian to execute the transaction. All the transfers57 are made through accounts held by the custodian who also takes custody of the securities involved in a repo and offers services to help sellers manage the best use of their collateral. Typically, in an overnight repo, before the reforms the previous day contracts ended early in the morning but the next day contracts began only late in the afternoon; therefore, because of this delay in settlement, the custodian banks used to extend intraday credit to the dealers (sellers of securities) until a new overnight repo was settled. Consequently, the custodian banks were exposed to dealer default and the repo parties were exposed to custodian bank default.
The reforms aimed, among other things, at reducing the market’s reliance on discretionary extension of intraday credit by the custodian banks,58 which contributed to the market’s fragility during the crisis (FRBNY 2012). The reforms have succeeded in reducing the share of tri-party repo volume that is financed with intraday credit from a clearing bank below the Task Force’s original target of 10%. However, there are still concerns and issues to be solved, in particular regarding the risk of fire sales of collateral by creditors of a dealer that has defaulted. According to the FRBNY, “no mechanism exists to address the challenge of coordinating sales of collateral of a defaulted dealer in an orderly manner” (FRBNY 2015).
The Post-crisis Regulation of Shadow Banking in the European Union
In 2013, the EU, following consultation on the Green paper on shadow banking issued in 2012, set out a road map to implement measures aimed at tackling financial risks emerged from the unregulated sector. In particular, the Commission intended to “take initiative such as transparency of the shadow banking sector, establishment of a framework for money market funds, reform of rules for undertakings for collective investment in transferable securities (UCITS), securities law and risks associated with securities financing transactions (principally securities lending and repurchase transactions) and establishment of a framework for interactions with banks” (Communication from the Commission to the Council and the European Parliament 2013). As a consequence, a series of regulations and directives were issued and/or updated in the following years. In particular, regarding the interconnectedness between the shadow banking sector and the regulated banking sector (indirect regulation), CRD IV (Capital Requirement Directive, 2013/36/EU) and CRR (Capital Requirement Regulation, n.575/2013) introduced in the EU law the bulk of the international standards agreed by the Basel Committee on Banking Supervision in 2010, known as Basel III. They reinforced, among other things, the capital requirements imposed on banks in their transactions with the shadow banking system enhancing, for example, the existing capital requirements for banks derivative transactions and counterparty credit risk that stems from them.59 While higher capital requirements and the recovery and resolution framework may contribute to improve the resilience of an individual bank,60 the proposal of a regulation by the European Council (June 2015) “Regulation on structural measures improving the resilience of credit institutions” was meant to address the risk posed by large, complex, and interconnected credit institutions.61 After years of negotiations without reaching an agreement, the European Commission withdrew the proposal in the 2018 working program (EU Commission 24/10/2017—Com (2017), 650 final, Annex 4). The reasons given for withdrawal were the lack of progress in the negotiations since 2015 and the alleged recognition that the objectives of the proposal had already been achieved by other regulations. As for the regulation of entities, on June 30 2017, the new European Regulation for Money Market Funds was published on the Official Journal of the EU.62 The Regulation applies to all MMFs established, managed, or marketed in the EU. The EU reforms, as the ones in the United States, aimed to make MMFs more resilient to market shocks and to protect investors in the event of large cash withdrawal during periods of high volatility. Under the regulation, there are three different kinds of MMFs: (1) public debt CNAV MMFs: a funds that can operate at CNAV if invest at least 99.5% of its portfolio in public debt securities, reverse repo secured with government securities, and cash; (2) variable net asset value (VNAV) MMFs: these funds can be classified as short-term funds or standard VNAV funds. The standard funds typically aim at higher returns and invest in assets with longer maturities; (3) low volatility net asset value (LVNAV) MMFs: a new category of funds which is a hybrid between the existing CNAV and the VNAV MMFs. One characteristic of LVNAV is that shares can be issued or redeemed at a CNAV per share as long as such price does not deviate by more than 0.20% from the NAV calculated in accordance with market prices. Both CNAV and LVNAV funds are permitted to use amortised cost accounting for the valuation of assets, but LVNAV funds may only use it for securities with a maturity of 75 days or less. The regulation introduces, among other things, new liquidity requirements in order for MMFs to be able to satisfy investor redemptions and portfolio diversification requirements to avoid undue exposure to a single issuer. In addition, the regulation details the circumstances under which the board of public-debt CNAV and LVNAV funds may decide to impose redemption gates and/or liquidity fees and when such action is mandatory. To avoid that an underperforming fund affects the rest of the financial sector, the regulation prohibits for all MMFs financial assistance (sponsor support) from a third party. Finally, MMF managers are required to operate a rigorous credit assessment process that is to invest in high-quality and well-diversified assets without over-reliance on credit rating provided by third parties and to provide greater transparency of information to investors and regulators.
Other forms of shadow banking entities are regulated through the Alternative Investment Fund Managers Directive (AIFMD), 2011/61/EU. The AIFMD applied to managers of funds that are not UCITS,63 including hedge funds, private equity funds, and retail estate funds. The Directive aims to create a single harmonised regulatory framework for EU established managers of Alternative Investment Funds (AIFs) as well as to set out a regime for the marketing in the EU of both EU and non-EU AIFs by non-EU managers. Under the Directive, authorised managers can sell shares of AIFs through Europe to professional investors on the basis of a passport regime. Authorised managers are subject to a number of obligations relating, for example, to governance, capital requirements, and remuneration policies. In particular, managers are required to provide national authorities with a set of information on aspects such as their investment portfolio, leverage, and collateral. To reduce systemic risk, authorised managers are also subject to limitations on leverage. As for the instruments of shadow banking, the Securitisation Regulation (Regulation EU 2017/2042) came into force on January 2018 and became applicable across the EU on January 1, 2019. The Regulation provides a general framework for securitisation combining and reforming existing sectoral legislation in one single regulation and as such it applies to institutional investors, to sponsors, original lenders, and securitisation special purpose entities. The Regulation establishes requirements for, among other things, due diligence, risk retention,64 and transparency for all parts involved in the securitisation process. In addition, the Regulation aims to create a more risk sensitive and prudential framework for “simple, transparent and standardised” (STS) long-term securitisation and asset-backed commercial paper program. The label STS is meant to help investors in their own due diligence process. The Regulation sets out a series of criteria for a securitisation to comply with in order to be considered a “STS” and regarding, for example, portfolio and cash flow, investor data availability, and structural elements. In addition, the Regulation sets out the conditions under which certain institutional investors (banks and investment firms) can benefit from more profitable regulatory capital treatment for STS securities exposures. The Regulation, given the complex structure of the re-securitisation process that makes difficult to assess the risk involved, introduces a ban on re-securitisation subject to derogation for some asset-backed commercial paper programs.
The Regulation (EU) 2015/2365 (SFTR) which entered into force on January 2016 aims to enhance transparency on the market of securities financing transactions (SFTs) (mainly securities lending and borrowing and repurchase agreement) and of the reuse of financial instruments provided as collateral by counterparties. The SFTR introduces three requirements: transaction reporting, disclosure, and collateral reuse obligation. In fact, SFTR requires financial and non-financial counterparties to report their SFTs to approved registered EU trade repository. SFTR also requires information on the use of SFTs by investment funds to be disclosed to investors in the regular report and pre-investment documents issued by the funds. SFTR also sets out minimum transparency conditions to be fulfilled by the receiving counterparty before re-using the collateral such as disclosure of the risks to the providing counterparty and the obligation to acquire prior express consent.
The derivatives contracts which are another important component of shadow banking are covered by the Regulation 648/12 known as EMIR (European Market Infrastructure Regulation) which set out requirements for the clearing of OTC derivatives through authorised counterparties (CCPs), and risk mitigation requirements for non-cleared derivatives, as well as post-trade reporting requirements for all OTC derivatives.65
Notwithstanding these reforms, shadow banking has continued to be a source of systemic risk because of emerging new risks and vulnerabilities. For example, following the reforms of the OTC derivatives markets (which include mandatory central clearing of standardised OTC derivatives), inevitably the increased share of central clearing has been associated with further risk concentration in CCPs. Thus in the 2015 G20 Summit, the G20 Leaders affirmed that “Critical work remains to build a stronger and more resilient financial system. In particular, we look forward to further work on central counterparty resilience, recovery planning and resolvability…. We will continue to monitor and, if necessary, address emerging risks and vulnerabilities in the financial system, many of which may arise outside the banking sector. In this regard, we will further strengthen oversight and regulation of shadow banking to ensure resilience of market-based finance, in a manner appropriate to the systemic risk posed” (G20 Leaders’ Communique’ 2015). Mark Carney (governor of the Bank of England and former chair of the FSB), in his speech at the Institute of International Finance’s Washington Policy Summit (April 2017), asserted that, due to the reforms implemented, “the financial system is safer, simpler and fairer”. In particular he underlined that “The system is simpler because a series of measures are eliminating the fragile forms of shadow banking while reinforcing the best of resilient market based finance”. Therefore, he welcomed the growth of global asset under management which have grown from around $50 trillion a decade ago to $77 trillion in 2015: “This growth creates new sources of funding and investment, promotes international capital flows, reduces reliance on bank funding, and brings welcome diversity to the financial system.” On the other hand, he admits that “asset management’s importance reinforces the need to minimise the risk of sudden stops in times of stress. The FSB estimates that in 2015 more than $20 trillion of assets were held in funds susceptible to such risk” (Mark Carney 2017, ibidem) As for the CCPs, “CCPs reduce contagion risks in banking, and they make the massive derivatives market more robust. The extent to which they reduce overall systemic risks, however, depends on their resilience and resolvability” (Mark Carney, ibidem). The sector is continuing to grow. According to the newly appointed FSB director, Randal K Quarles, “Since the global financial crisis, non-bank financing has grown relatively rapidly, in both its absolute size and its relative importance in intermediating credit. In the jurisdictions that the FSB closely monitors, non-bank financial assets are just under 50 percent of total global financial assets, a share that has grown by close 5 percentage point since 2009” (Quarles 2019). He asserted that “…the shift within the financial system toward non bank financing represents a welcome increase in the diversity of the source of lending to both firms and households” but he also acknowledges that “…Non bank financing can also lead to lower lending standards, bidding up the price of risky assets and sending an encouraging signal to credit underwriters. More recently, new forms of interconnectedness between non bank financial firms and the banking system have emerged that could, in some scenarios, act as channels for domestic and cross-border amplification of risks” (ibidem). The assets of other financial intermediaries (OFIs) grew by 7.6% to $116.6, 6 trillion globally in 2017. OFIs assets represent 30.5% of total global assets, the largest share OFIs have had on record. Investment funds constitute the largest OFI subsector (FSB 2019).
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