Legislation needed to break non-bank deadlock – BIS’s Borio

A full macro-prudential framework for the non-bank sector will “remain beyond reach” unless securities regulators are given a financial stability mandate in law, Claudio Borio said today (February 26).

The head of the Bank for International Settlements’ monetary and economic department said efforts by the Financial Stability Board to develop non-bank regulation had failed to fully address the vulnerability of the non-bank sector.

Regulation implemented in the wake of the global financial crisis is widely seen as having pushed financial activity into the non-bank sector. Non-banks now account for roughly half of global financial assets, but tend to be lightly regulated. 

During a panel discussion hosted by the Bank of England (BoE), Borio said the migration of activity into the sector had been foreseen and even welcomed by the regulators who developed the Basel III framework. However, he added that the assumption had been that non-bank regulation would keep pace with banking regulation. It has not.

A key problem, Borio argued, was that many non-banks are overseen by securities regulators. These typically have investor protection mandates, rather than a focus on financial stability.

“It is a legislator who has to take the initiative here,” he said. He recommended securities regulators be given a mandate to regulate each non-bank firm in its entirety – on an entity level – or on the basis of its activities.

BoE executive director Victoria Saporta agreed with Borio that “a combination” of activity- and entity-based regulation was needed. She noted that it is entities that have a “corporate identity” – they are supervised, can be targeted by enforcement, and can fail. However, similar risk-taking activities are spreading across a range of businesses, some of which are not standard financial firms. 

It is a legislator who has to take the initiative here

Claudio Borio, BIS

Elena Carletti, a professor of finance at Bocconi University, said that some risky activities – often those undertaken by banks – were regulated tightly, while similar activities at a non-bank entity might not be regulated at all.

Carletti said regulators previously used the “excuse” that banks are special because they take deposits. Now that many non-banks are taking on bank-like risks such as liquidity and maturity transformation, she said she was “not so sure we can maintain that justification”. She called for greater use of activity-based regulation.

Loriana Pelizzon, an economics professor at Ca’ Foscari University of Venice, added that risks were spreading beyond market-based non-bank firms. She said that businesses such as tech firms were increasing becoming involved in activities that had once been the domain of banks.

She urged regulators to “think ahead” to a more complex financial system characterised by much more technology. However, she said the risks themselves will be familiar, and that tech firms “will create similar problems in a new setting”.

Saporta asked the panel how risks could be prevented from migrating further through the financial system if the rules were tightened in particular areas. Borio said the situation was like an “arms race” and that regulators “have to engage in it”. He argued that giving securities regulators a clearer mandate would be a “first step”, after which “I think the discourse is going to change”.

Borio and the other panellists warned that banking regulations, though much tighter than those applied to the non-bank sector, are far from perfect.

Both he and Carletti highlighted interest rate risk as a key vulnerability. Such risk played a central role in the failure of Silicon Valley Bank and a handful of other US banks in March 2023. 

Borio argued that interest rate risk needed to be moved into Pillar 1 of the Basel framework, which would create a global minimum standard for regulations. It currently falls under Pillar 2, meaning it is down to supervisory discretion.

Carletti said a similar degree of resilience could be achieved by tightening up supervisory frameworks. She said Europe’s Supervisory Review and Evaluation Process was a formal and transparent process that should be replicated elsewhere. She criticised the US version, known as Camels, for being too opaque and for paying too little attention to interest rate risk.