FSB wants non banks to further cut leverage to reduce liquidity stress

Rick Steves

The findings of this report will inform further policy development efforts aimed at strengthening the ability of authorities and market participants to identify, monitor, and contain systemic risks associated with leverage in NBFI.

The Financial Stability Board (FSB) has released its annual progress report to the G20, shedding light on efforts to bolster the resilience of non-bank financial intermediation (NBFI) amid growing concerns over liquidity stress in the sector.

The report underscores the importance of addressing vulnerabilities, particularly those related to leverage, and outlines key policy implications.

The report presents the results of analytical work aimed at identifying vulnerabilities in specific entities and activities within the NBFI sector that could contribute to aggregate liquidity imbalances.

It also highlights ongoing efforts by the FSB and standard-setting bodies (SSBs) to curb excessive and potentially destabilizing spikes in liquidity demand, with a focus on structural liquidity mismatches in open-ended funds and margining practices.

Focus on tackling risks stemming from leverage

One of the central messages of the report is the importance of ensuring that various policies are coherent from a system-wide perspective. It warns that vulnerabilities observed in recent market incidents persist until these policies are finalized and fully implemented.

The report outlines further steps to assess and address systemic risks within the NBFI sector, detailing forthcoming work by the FSB and SSBs in this regard.

A key policy focus for 2024 will be tackling financial stability risks stemming from NBFI leverage. Leverage, a financial mechanism used to amplify exposure and returns or offset potential losses, is at the forefront of concerns.

Accompanying the annual progress report, the FSB has also published a dedicated report on the financial stability implications of leverage in non-bank financial intermediation. This report provides an overview of aggregate NBFI leverage trends across FSB jurisdictions and identifies vulnerabilities associated with that leverage.

The report identifies pockets of high leverage within the NBFI sector, particularly in hedge funds. However, it also acknowledges certain data gaps that make it challenging to fully assess these vulnerabilities. To address these concerns, the FSB proposes several policy implications:

Addressing Data Gaps: Consider using trade repository data, enhancing reporting requirements for non-banks with high leverage, and expanding disclosure requirements to improve transparency.

Containing Excessive Leverage Behavior: Conduct further work on haircuts and margins for derivatives and securities financing transactions to prevent excessive leverage.

Mitigating Financial Stability Consequences: Explore measures to enhance prime brokers’ risk management and enhance the liquidity preparedness of non-bank investors to minimize the potential fallout of high NBFI leverage.

The FSB, in collaboration with SSBs, is already engaged in addressing these issues as part of its NBFI work program. The findings of this report will inform further policy development efforts aimed at strengthening the ability of authorities and market participants to identify, monitor, and contain systemic risks associated with leverage in NBFI.

This initiative follows the FSB’s Holistic Review of the March 2020 Market Turmoil, which set out an ambitious program to enhance the resilience of the NBFI sector while preserving its benefits. The FSB has been actively working on this program alongside its member standard-setting bodies and international organizations.

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