Systemic risk stoked by growth in shadow banking

Fitch reported that global shadow banking reached US$52 trillion, 13.6% of total financial assets, at the end of 2017, up from US$30 trillion at the end of 2010, according to data from the Financial Stability Board (FSB).

The growth in shadow banking since the financial crisis was “driven by bank regulation, low interest rates, the favourable economic backdrop and the growth of financial technology”, Fitch said.

Alongside the rise of the non-bank sector, systemic risk may be rising too, it suggested.

“These [risks] could include direct and indirect exposures faced by banks, insurance companies and pension funds, reduced financing availability for banks and non-financial corporate borrowers, and increased asset price volatility,” it said.

In particular, investment funds have been the biggest driver of shadow banking growth, Fitch said.

“Forced asset sales or outsized redemptions could negatively affect asset prices and the broader financial system, particularly if the underlying assets are less liquid and/or the funds are materially levered,” it said.

At the same time, Fitch said that new sources of credit and liquidity could also prove positive for the financial system.

“How shadow banking entities perform through the next credit cycle will determine whether this more diffuse but less transparent and more lightly regulated construct is more beneficial for the overall financial system versus the prior, more bank-concentrated model,” it said.

In the meantime, Fitch said shadow bank risk could be reduced by ramping up regulation, more transparent financial reporting and limitations on asset/liability mismatches, among other measures.

“However, regulators would need to balance any such changes against the need for prudent expansion of capital and credit availability, particularly for under-banked and developing economies,” it said.