Expect Nonbank Financial Regulation to Intensify in 2024

As nervous banks have pulled back from their traditional role in financing, large nonbank institutions — such as insurance companies, hedge funds, private equity, and mortgage REITs — have moved in. Global regulators are looking at the phenomenon and considering how they should extend their oversight.

The Financial Stability Board (FSB), which coordinates international standard-setting and financial authorities, has said that even as so-called nonbank financial intermediation (NBFI) sector had its first notable annual decrease since 2009, it still had assets of $217.9 trillion. The number represented 47.2% of total global financial assets and represents what is known as shadow banking. And that will be a major focus of the FSB as well as the International Organization of Securities Commissions (IOSCO) in 2024, with an emphasis on leverage.

The two organizations published a joint statement on “liquidity mismatch,” when there can be a mismatch between the booked values of assets on a balance sheet and the practical recognized market value because of a factor like maturity or lack of demand.

Such a liquidity mismatch drove the implosions of several high-profile U.S. banks early in 2023. They held government and mortgage securities with yields low compared to high interest rates the Federal Reserve had set to battle inflation. When interest rates rise, existing bond values drop.

U.S. regulators recently decided to create an “analytic framework” for nonbank financial security risks.

Insight into the liquidity mismatches, which are forms of leverage, of nonbanks, also called open-ended fund managers, is opaque. Also, such institutions aren’t covered by minimum liquid capital holdings that are mandated for banks. Given the share of global assets such institutions have, the FSB and IOSCO are concerned about the effects they could have on global finances.

“That will probably be the big attention grabber because leverage within NBFI is harder to track, it’s harder for us in the central banking community to monitor,” FSB Secretary General John Schindler told Reuters in an interview.

“Leverage can go in all directions. The challenge, let us be clear, is about data,” IOSCO Chair Jean-Paul Servais told Reuters. “It [data] will be the challenge before thinking about possible policy initiatives.”

Such data is typically outside the authorities of regulators, though FSB and IOSCO hope to work with central banks to rectify that. More regulation could affect how the nonbanks operate, including the money they make available for lending to commercial real estate ventures.