The Shadow Banking To GDP Ratio Has Risen From 55% In 2012 To 59% In 2014

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The Shadow Banking To GDP Ratio Has Risen From 55% In 2012 To 59% In 2014 by Financial Stability Board

H/T Robin Wigglesworth

Executive summary

The shadow banking system can broadly be described as credit intermediation involving entities and activities outside of the regular banking system.1 Intermediating credit through non-bank channels can have important advantages and contributes to the financing of the real economy, but such channels can also become a source of systemic risk, especially when they are structured to perform bank-like functions (e.g. maturity and liquidity transformation, and leverage) and when their interconnectedness with the regular banking system is strong. Appropriate monitoring of shadow banking and the application of appropriate policy responses, where necessary, helps to mitigate the build-up of such systemic risks.

This report presents the results of the fifth annual monitoring exercise using data as of end-2014 for 26 jurisdictions, including Ireland for the first time, and the euro area as a whole, which together account for about 80% of global GDP and 90% of global financial system assets.

This year’s report introduces an enhancement to the monitoring methodology as a further step towards narrowing the focus to those parts of non-bank credit intermediation where shadow banking risks such as maturity transformation, liquidity transformation or leverage may occur. A new activity-based “economic function” measure of shadow banking has been introduced, based on the high-level policy framework published by the FSB in August 2013 and described in an annex of last year’s Global Shadow Banking Monitoring Report. In order to ensure a certain degree of consistency in reporting, all authorities were guided to report non-bank credit intermediation if such activity was considered to give rise to shadow banking risks in at least some jurisdictions.5 As a result, the narrow measure presented in this year’s report may overestimate the degree to which non-bank credit intermediation gives rise to systemic risks. Since this was the first time that many jurisdictions took part in the assessment and this remains a work in progress, FSB members will continue to deepen their understanding of shadow banking and any potential risks through greater data availability and information sharing. As such, the narrow measure of shadow banking may be subject to some degree of change in future reports.

The Narrow Measure

  • Based on a new methodology for assessing non-bank financial entities and activities by “economic functions” introduced this year, the narrow measure of global shadow banking that may pose financial stability risks amounted to $36 trillion in 2014 for the 26 participating jurisdictions. This is equivalent to 59% of GDP of participating jurisdictions, and 12% of financial system assets, and has grown moderately over the past several years.
  • More than 80% of global shadow banking assets reside in a subset of advanced economies in North America, Asia and northern Europe.
  • The new classification by economic functions shows that credit intermediation associated with collective investment vehicles with features that make them susceptible to runs (e.g. money market funds (MMFs), hedge funds and other investment funds) represents 60% of the narrow measure of shadow banking. It has grown more than 10% on average over the past four years. By contrast, the level of securitisation-based credit intermediation – among the key contributors to the financial crisis – has fallen in recent years.
  • At the aggregate level, interconnectedness between the banking and the non-bank financial system, excluding those OFIs that are prudentially consolidated into banking groups, continues to decrease from its pre-crisis peak. However, in some jurisdictions, OFIs’ credit and funding exposures to banking systems are reported to be quite high and merit further assessment as to the extent of concentration of exposures and underlying risks.
  • The measurement of shadow banking risks – including leverage, liquidity and maturity transformation, and imperfect credit risk transfer – continues to face challenges in data availability. The FSB held a workshop for participating jurisdictions to assess economic classifications, associated risks and the availability of policy tools to address and mitigate material vulnerabilities to the financial system.

Shadow Banking

The Broad Measure

  • An aggregate “MUNFI” measure of the assets of other financial intermediaries (OFIs), pension funds and insurance companies grew by 9% to $137 trillion over the past year, and now represents about 40% of total financial system assets in 20 jurisdictions and the euro area.6 In aggregate, the insurance company, pension fund and OFI sectors all grew in 2014, while banking system assets fell slightly in US dollar terms.
  • Based on assets of OFIs alone, which have been the main focus of last year’s report, (i.e. excluding pension funds and insurance companies), non-bank financial intermediation of the 20 jurisdictions and the euro area rose $1.6 trillion to $80 trillion in 2014. This growth was due to a combination of higher equity valuations and a substantial increase in non-bank credit intermediation, largely from capital markets.
  • While non-bank financial intermediation shrank somewhat immediately following the financial crisis, it has been rising over the past several years. OFI assets in the 20 jurisdictions and the euro area reached 128% of GDP in 2014, up 6 percentage points from 2013 and 15 percentage points from 2011. It is nearing the previous high-point of 130% prior to the financial crisis.
  • Emerging market economies (EMEs) showed the most rapid increases in OFI assets. In 2014, 8 EMEs had OFI growth rates above 10%, including two that grew over 30%. However, this rapid growth is generally from a relatively small base. While the nonbank financial system may contribute to financial deepening in these jurisdictions, careful monitoring of potential systemic risks caused by a rapid expansion of the nonbank sector is needed.
  • Among OFI sub-sectors that showed the most rapid growth in 2014 are trust companies, MMFs, and fixed income and other funds. Trust companies (mostly based in China) continued to experience growth of 26%, similar to the past several years. Perhaps more surprisingly, MMFs experienced 20% growth in 2014 (largely driven by some euro area jurisdictions and China), following low or negative growth in the prior three-year period. Fixed income funds and other funds grew approximately 15% in 2014. It should be noted that hedge funds remain underestimated in the FSB’s exercise due to the fact that a portion of international financial centres (IFCs), where a number of hedge funds are domiciled, are currently not within the scope of the exercise. The inclusion of IFCs in the regional monitoring report by the FSB’s Regional Consultative Group (RCG) for the Americas has helped to fill this gap (see Annex 3). More frequent updates of the IOSCO Hedge Fund Survey could provide important additions to the Global Shadow Banking Monitoring Report.

Shadow Banking

Methodological improvements

This year’s report introduces several enhancements related to the methodologies to assess the size, activities and potential risks of shadow banking. As described in Section 2, the economic functions approach is based on the classification of non-bank financial entities into five economic functions through which non-bank credit intermediation may pose bank-like systemic risks to the financial system8. Through this process, each jurisdiction identified and sought to remove non-bank entities that in its supervisory judgment, do not engage in credit intermediation and also those that are prudentially consolidated into banking groups.

These steps resulted in about a 71% reduction from the broad Monitoring Universe of Nonbank Financial Intermediation (MUNFI) estimate for the sample of 26 jurisdictions. The narrowing down approach through economic function classification uses more granular data and information provided by jurisdictions, including some degree of supervisory judgment to determine where shadow banking risks may arise.9 This year’s report reflects the start of a process by which authorities’ exclusion of entity types that they assess as not engaging in any of the defined economic functions has been subject to collective review by peer jurisdictions. The exercise took a conservative approach of including entity types into the narrow measure for all jurisdictions if the activities associated with non-bank credit intermediation could give rise to shadow banking risks at least in some jurisdictions. This year’s report also seeks to explain where jurisdiction-specific exclusions from the narrow measure have occurred, and the rationale for such differences in classification (see Annex 1). To foster aligned approaches, the activity-based narrow measure remains a work in progress and is expected to improve over time with increased data availability, more consistency in the assessments and a deeper understanding of the shadow banking system.

Shadow Banking

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