BIS calls for systemic approach to non-banks

The Bank for International Settlements is calling for policy-makers to regulate non-banks at the system-wide level.

Agustín Carstens, BIS general manager, cited the “massive central bank support” undertaken in March 2020 to argue that “fundamental adjustments to the regulatory framework for NBFIs [non-bank financial intermediaries] are called for”.

The Basel-based institution’s quarterly review observed that NBFIs tend to amplify procyclical trends in the financial system. Because many NBFIs – like money market funds or stablecoin issuers – have to sell illiquid assets for cash in a crisis, they can amplify swings in markets. Some NBFIs, like hedge funds, pose additional problems because they tend to rely heavily on leverage.

The BIS argues regulators should extend the macro-prudential approach they adopted towards banks to the NBFI sector. In its paper, the BIS says regulators may find that individual institutions are all healthy, and acting rationally in response to crises. However, if they all deleverage at once, or buy up liquid assets, financial networks will cease to function.

The quarterly report also proposes that NBFIs build up buffers to ensure they could meet creditor and depositor demands during crises. Claudio Borio, head of the BIS economic and monetary department, spoke of NBFIs building “war chests” at the press conference accompanying the paper’s release.

The report says central banks should not become a regular backstop for non-banks. “The expectation of such assistance creates moral hazard and distorts prices,” it says. Emergency funds can also conflict with monetary policy, should the central bank need to combat inflation.

“It is extremely important to avoid… repeated interventions by central banks,” Borio said.

Carstens writes that “massive central bank support was necessary to restore the calm” in 2020, and that “such repeated occurrences suggest that the status quo is unacceptable”.

Thorsten Beck, professor of financial stability at the European University Institute in Florence, says that it can be difficult for central banks to say they will never bail out non-bank financial institutions. “New sources of fragility and new fault lines can arise in future crises and require again [central bank] support”, Beck tells Central Banking, adding that NBFIs can expect intervention “if they are large enough (in size and numbers) and systemically important enough”.

Non-bank financial intermediaries – which include hedge funds, money market funds and asset management funds, among others – account for around $200 trillion in assets. This is nearly half of all assets in the global financial system.

Complicated outlook

In its overview of the economic situation in recent months, the BIS found that equity markets had done well until the emergence of the Omicron variant of the coronavirus. “The correction that eventually shook markets at the end of the period erased part of the previous gains in the United States, and left most other markets flat or with some losses,” the quarterly report notes.

Borio told reports that “we should not lower our guard” in the face of Omicron, but that “it’s still a bit early days” to say what its effects will be. “Some impact is inevitable, particularly in the first quarter of 2022,” he said, before adding the BIS believes the economic recovery will continue overall.

BIS researchers also observed a divergence between central bank guidance on monetary policy and market expectations about what central banks would actually do. The report hypothesises that bond markets disagreed with central bankers about inflation forecasts. The “disconnect” made bond yield curves more volatile.

Corporate bond markets, on the other hand, remained healthy during the reporting period.

The quarterly report also details the troubles of emerging markets. These are struggling with rising inflation, a stronger US dollar and weakening domestic economies. Upward pressures on prices and downside expectations on growth create a dilemma for monetary policy-makers. These economies also lack the same ability to tailor fiscal policy as advanced economies do.

Hyun Song Shin, BIS head of research, noted that emerging markets could face problems accessing capital flows, excepting those in Asia. He noted that China has enjoyed “sustained flows” of capital.