Non-banks play an increasingly important role in the global financial system. It is important therefore that risks from non-bank financial intermediation (NBFI) are effectively managed and that authorities have the tools they need to effectively supervise and regulate NBFI.

The FSB has undertaken significant work to assess and address the risks from NBFI since the global financial crisis. A key pillar of the FSB’s work has focused on its annual exercise to monitor NBFI activities and implementing a range of reforms agreed to address problems highlighted by the global financial crisis.

The FSB’s regular vulnerabilities work assesses risks across the financial system including risks that may be developing with NBFI. This work is supplemented with deeper dives to better understand emerging risks and agree what coordinated supervisory and regulatory action should be taken.

Developments in credit markets

The impact of COVID-19 on credit markets highlighted vulnerabilities in the NBFI sector related to liquidity mismatches, leverage and interconnectedness, and investor behaviour related to certain funds that they may treat as cash equivalents during economic calm but not during crisis. While extraordinary central bank interventions calmed capital markets, which remained open and enabled firms to raise new and longer-term financing, such measures should not be required.

Understanding risk, risk transmission, and policy implications for the NBFI sector is more important than ever. Authorities across the financial sector must develop a shared understanding of our financial system as a whole and build consensus where policy responses may be needed. The FSB has formed a group on non-bank financial intermediation, composed of senior leaders from market regulators, macroprudential authorities, and international organizations, which will build a holistic view of resilience in the NBFI sector. By the G20 Summit this November, the group will carry out a holistic review of the market turmoil that occurred in March by leveraging the various workstreams underway in the FSB and SSBs. In addition, the FSB has begun a mapping exercise of the critical connections between traditional banking and non-bank sectors in a cross-border setting. This combined work will clarify the various points of vulnerabilities and risk amplification and transmission in the financial system, and will inform future steps of the FSB. In 2021 under the Italian G20 Presidency to improve the resiliency of the NBFI sector while preserving its benefits.

Leveraged loans and collateralised debt obligations

 The FSB has highlighted concerns about growing levels of debt in the financial system and deteriorating underwriting standards.

Markets for leveraged loans and collateralised loan obligations (CLOs) have grown significantly in recent years, with the majority of issuance concentrated in the US and to a lesser extent the European Union. The securitisation of leveraged loans through CLO issuance, which had come to a halt almost entirely between 2009 and 2010, exceeded pre-crisis levels in 2014 and has remained strong since then. While most leveraged loans are originated and held by banks, and banks have the largest exposure to the market, the role of non-bank financial institutions has increased.

In December 2019 the FSB published a report that reached the following conclusions:

  • Vulnerabilities in the leveraged loan and CLO markets have grown since the global financial crisis. Borrowers’ leverage has increased; changes in loan documentation have weakened creditor protection; and shifts in the composition of creditors of non-banks may have increased the complexity of these markets.

  • Banks have the largest direct exposures to leveraged loans and CLOs. These exposures are concentrated among a limited number of large global banks and have a significant cross-border dimension.

  • A number of non-bank investors, including investment funds and insurance companies, are also exposed to the leveraged loan and CLO markets.

  • Given data gaps, a comprehensive assessment of the system-wide implications of the exposures of financial institutions to leveraged loans and CLOs is challenging.

The FSB will is considering what steps can be taken to close data gaps and continues to analyse the financial stability risks. It has also continued to assess the regulatory and supervisory implications associated with leveraged loans and CLOs.