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New rules to boost financial stability in Non-Bank sectors!


New rules to boost financial stability in Non-Bank sectors

The Financial Stability Board (FSB), an influential body under the G20, recently suggested that entities outside the traditional banking sector, such as insurance companies, hedge funds, family offices, and commodities traders, maintain adequate cash reserves and develop emergency plans to manage potential spikes in collateral demands. Collateral is crucial in backing derivatives positions against defaults, and the FSB's initiative is designed to ensure these non-bank financial institutions (NBFIs) can withstand financial stresses without the need for central banks to provide emergency liquidity. This move reflects a proactive approach to prevent future financial crises by enforcing more stringent liquidity preparedness among diverse financial entities.


Representing nearly half of the global financial system, non-bank financial institutions are increasingly under the regulatory microscope. This heightened scrutiny aims to avert situations where central banks have to step in and supply liquidity to stabilize markets during financial disruptions. Such interventions have historically occurred during periods of acute financial stress, such as the global financial crisis of 2008 and more recent liquidity crises. By focusing on these non-banks, regulators are attempting to extend rigorous financial safeguards across a broader swath of the financial sector, thereby reducing systemic risks and enhancing overall market stability.



Past financial episodes, such as the global dash for cash following the onset of the COVID-19 pandemic in March 2020, have highlighted the vulnerability of non-banks to sudden liquidity shortages. This was also evident when unexpected economic announcements, like the unfunded tax cuts in the UK in September 2022, placed additional strains on certain financial entities. Such events have prompted regulatory bodies to reevaluate and enhance the liquidity management frameworks of non-banks to better prepare them for similar challenges in the future.


The Archegos family office collapse in March 2021 and the subsequent volatility in commodities markets following geopolitical developments, such as Russia's invasion of Ukraine, revealed significant weaknesses in some non-banks’ ability to manage sharp increases in margin calls. Margin calls occur when an investment’s value falls below a certain level, requiring the investor to add more funds to maintain their position. The FSB identified these weaknesses as stemming from inadequate liquidity risk management and governance practices within certain non-bank entities. This has led to recommendations for strengthening such practices across the sector.


The FSB’s report, which is now available for public consultation, offers several recommendations aimed at improving the liquidity resilience of non-banks. These include integrating robust mechanisms to handle collateral spikes and developing contingency plans to ensure liquidity can be maintained during periods of financial stress. These recommendations are intended to make non-banks more self-sufficient in managing their liquidity needs and less reliant on central bank interventions, which have historically been necessary during market disruptions.



The report emphasizes the need for non-banks to have substantial cash reserves and a diverse array of liquid assets that can be quickly converted into cash in stressed market conditions. This directive is part of a broader strategy to enforce more uniform and stringent liquidity regulations across the financial spectrum, contrasting with the sometimes vague or inconsistent rules currently governing non-banks. By proposing clearer guidelines, the FSB aims to fortify the financial system against potential liquidity crises that could destabilize both national and global economies.


The FSB, composed of treasury officials, central bankers, and regulators from the Group of 20 countries, formulates policies that G20 members are expected to implement. These measures are designed to address the gaps in current regulatory frameworks, particularly in contrast to the well-defined liquidity requirements that banks face. This focus on non-banks is critical given the recent financial instabilities, such as the collapse of several U.S. regional banks, highlighting the need for robust regulatory measures across all financial entities.



Non-banks, particularly in sectors like insurance in Britain and the European Union, currently face a lack of specific regulations regarding how they manage collateral and margin calls under existing solvency rules. Similarly, hedge funds employing high levels of leverage are only minimally affected by directly applicable liquidity risk regulations. The FSB’s observations extend to commodities traders, who are not subject to the stringent liquidity requirements that banks must adhere to, indicating an expansion of the regulatory net to include a wider range of financial participants. This broadening of scope is a crucial step towards ensuring a more resilient financial system capable of withstanding a variety of stressors.


17.04.2024



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