Ensuring Financial Stability
The Financial Stability Board (FSB) is calling on regulators to continue to address vulnerabilities outside the formal banking system in rapidly expanding and, in most cases, heavily indebted areas such as private equity firms and hedge funds. The Chair of the global financial stability watchdog, Klaas Knot, has warned in a letter sent on July 22 to the leading global finance ministers and central bank governors of the G-20 that geopolitical tensions, rising debt levels, and high risks
must be closely monitored to prevent potential financial instability.
The Risk of a Potential Financial Crisis
The increasing activities in the financial sector are raising concerns about a potential financial crisis. Knot, who is also the chairman of the Dutch Central Bank, points out that regulators have not done enough to address the dangers posed by the extensive shift of financial activities outside the tightly controlled banking system towards the realm of non-bank financial intermediaries. This growing sector of “shadow banks” includes money market funds, asset managers, pension funds, insurers, hedge funds, private equity firms, ?
Credit Unions and Real Estate Investment Trusts
Credit unions and real estate investment trusts are financial institutions that play a significant role in the global financial system. With assets totaling 218 trillion dollars, these institutions manage nearly half of the world’s financial resources. However, despite their size and influence, vulnerabilities still exist within the financial system that need to be addressed to ensure stability.
In a letter to the official representatives of the G-20 ahead of their meeting in Rio de Janeiro on July 25 and 26, Knott highlighted the importance of addressing these vulnerabilities. He emphasized that efforts to enhance stability in the financial system must continue, as key weaknesses have not yet been eliminated.
The Financial Stability Board (FSB) has been focusing on the risks associated with non-bank financial services, recognizing the need to monitor and regulate these sectors to prevent potential threats to the global financial system.
Financial Market Turmoil Caused by Hedge Fund Collapse
In March 2020, a wave of panic swept through the financial markets as heavily indebted hedge funds faced a cash crunch, leading to mass sell-offs in bond markets. This anxiety was heightened by the collapse of family office Archegos Capital Management three years ago, which left investment banks with losses amounting to $10 billion.
Similar concerns arose following the debt market crisis in the United Kingdom two years ago, triggered by issues stemming from financial derivative strategies in pension funds. The recent market stress and liquidity dry-ups have highlighted the vulnerabilities in the financial system and the need for greater oversight and risk management.
The Risks of Non-Bank Financial Intermediaries
Financial intermediaries outside of traditional banks can create or increase systemic risk, according to experts. Vulnerabilities that have led to past incidents still exist, leaving the global financial system susceptible to future shocks. While progress has been made in addressing these risks, the implementation of agreed-upon policies for non-bank financial intermediaries varies across jurisdictions, with regulatory authorities potentially losing momentum.
The Growing Risks of Non-Bank Institutions in the Financial Sector
It has come to light that some non-bank institutions, such as hedge funds, brokers and dealers, and financial companies, have been accumulating additional risky debts through off-balance sheet positions, including currency swap transactions and forward contracts, the sizes of which have “significantly increased over the past decade.” The Financial Stability Board (FSB) has promised to publish a report proposing a “policy approach for authorized bodies to address systemic risk” from the risky obligations of non-bank entities and warns that this additional debt could “create
The Risks of Financial System Limitations
Financial systems are essential for the functioning of economies around the world. However, when these systems face limitations, it can lead to stress and even cause systemic disruptions. This was a concern raised by experts like Elizabeth McCaul, a member of the supervisory board of the European Central Bank, who warned about the potential risks posed by the rapid growth of non-bank entities.
McCaul’s worries echo comments made by other financial experts, highlighting the need for vigilance in monitoring and regulating these non-traditional financial actors. The Financial Stability Board, while lacking legal binding powers, plays a crucial role in bringing together global central bankers, financial ministers, and regulatory bodies to establish a common global framework for financial stability.
Financial Regulation and Market Stability
Financial regulation is essential for ensuring stability in investment funds. An agreement has been reached for investment funds to hold more liquid assets and to conduct stress tests to better withstand market shocks. In addition, the FSB is calling for stricter rules on cash fund redemptions, including penalties for investors who withdraw their money during crises.
Policies to address instability in money market funds have been introduced or changed in several countries, including the United States, Switzerland, South Korea, Japan, and India.
FSB Calls for Stronger Implementation of Financial Market Policies
The Financial Stability Board (FSB) has informed that while some countries like the United Kingdom, European Union, and South Africa are still in the process of developing or finalizing reforms, others like Indonesia are already implementing them. Despite vulnerabilities observed in certain jurisdictions, FSB is calling for a more serious progress in the implementation of agreed financial market policies aimed at “limiting the need for extraordinary interventions by central banks in stressful moments”.
