The “shadow banking system” can broadly be described as “credit intermediation involving entities and activities (fully or partially) outside the regular banking system”. Such intermediation, appropriately conducted, provide a valuable alternative to bank funding that supports real economic activity. The objective of the FSB’s work is to ensure that shadow banking is subject to appropriate oversight and regulation to address bank-like risks to financial stability emerging outside of the regular banking system, while not inhibiting sustainable non-bank financing models that do not pose such risks. The approach is designed to be proportionate to financial stability risks, focusing on those activities that are material to the system, using as a starting point those that were a source of problems during the crisis. It also provides a process for monitoring the shadow banking system so that any rapidly growing new activities that pose bank-like risks can be identified early and, where needed, those risks addressed.

At the November 2010 Seoul Summit, the G20 Leaders warned of a potential that regulatory gaps may emerge in the shadow banking system and requested the FSB to develop recommendations to strengthen the oversight and regulation of the shadow banking system. To this end, the FSB has developed a two-pronged strategy. First, it has created a system-wide monitoring framework to track developments in the shadow banking system with a view to identifying the build-up of systemic risks and enabling corrective actions where necessary (e.g. annual shadow banking monitoring exercise). Second, the FSB has coordinated the develop of policies in five areas where oversight and regulation needs to be strengthened to mitigate the potential systemic risks associated with shadow banking:

  1. mitigating the spill-over effect between the regular banking system and the shadow banking system;
  2. reducing the susceptibility of money market funds (MMFs) to “runs”;
  3. improving transparency and aligning incentives associated with securitisation;
  4. dampening pro-cyclicality and other financial stability risks associated with securities financing transactions; and
  5. assessing and mitigating systemic risks posed by other shadow entities and activities.

When implemented, this integrated set of policies should mitigate financial stability risks emanating from shadow banking and help to transform it into resilient market-based financing that will support sustainable economic growth.