The severe stock market correction predicted by some analysts has not happened – not yet at least. Meanwhile, financial regulatory authorities are focused less on equity markets and more on what they see as growing lending risks in the now huge non-bank financial intermediation sector or NBFI.
Last month, Andrew Bailey, the newly appointed chair of the Financial Stability Board (FSB) who is also governor of the Bank of England, highlighted to G20 finance ministers the need to remain vigilant to the risk of disruptive market moves as uncertainty weighs on economic growth, with systemic financial implications.
According to recent FSB data, the total size of the NBFI sector increased by 8.5% last year, more than double that of the banking sector, raising its share of total global financial assets to 49.1%. Of particular concern are the growing systemic linkages between non-banks and banks.
NBFI comprises entities that are involved in credit intermediation activities which may pose bank-like financial stability risks. They include money market funds, hedge funds, other investment funds, captive financial institutions and money lenders, central counterparties, broker-dealers, finance companies, trust companies and structured finance vehicles.
While established banks are perceived to be more generally well capitalised and more sound as a result of tightened regulation in the wake of the 2008 global financial crisis, the close lending relationship between banks and non-banks or “secondary banks” ranging from hedge funds to broker-dealers is seen as a growing source of risk.
In a report in April, the International Monetary Fund warned that “global financial stability risks have increased significantly. There are concerns about some highly leveraged financial institutions and their nexus with banking system and also about risks of market turmoil and challenges to debt sustainability for highly indebted sovereigns”.
Linkages
These concerns were echoed at a recent economic forum at the Foreign Correspondents Club of Japan. One speaker, Hung Tran, a senior fellow at the Atlantic Council and a former IMF official, said that the growing “non-transparent linkages between banks and non-banks” are one source of concern.
He cited the possibility of highly leveraged hedge funds getting into difficulty at a time of volatile asset values and rising interest rates, and of these problems being transferred quickly to banks via repurchase or repo transactions. He also pointed to connected lending between banks and non-banks in lending to the commercial real estate sector.
According to another speaker, Paul Sheard, former vice chairman of S&P Global and author of The Power of Money, “suddenly these connectivities or linkages appear and get hypercharged. No matter how much you regulate, you can’t eliminate the risk of a financial crisis because there is a fundamental mismatch between the fact that the financial system is exposed on the asset side to fundamentally illiquid assets and on the other side of the balance sheet, it is trying to transform [liabilities] into liquid assets.”
Veteran financial and economic analyst Jesper Koll cautioned that “the risk of some form of hurting happening literally within half an hour and putting a financial institution at risk is starting to develop” with the expansion of peer-to-peer lending such as between banks and non-banks and the acceleration of financial activity.
Financial regulators, it seems, are playing a game of whack-a-mole.
