Financial Stability Board Report - The shadows of banking are big

The Financial Stability Board (FSB) just released their new study Global Monitoring Report on Non-Bank Financial Intermediation 2019 which includes data through 2018. It provides a comprehensive analysis of the "shadow banking" system now referred to as "non-bank financial intermediation" (NBFI) with a lot of details on the credit system outside banks. 

• Shadow banking continues to grow and is critical part of global financial intermediation, albeit market share for non-bank financial intermediation has declined slightly.
• The relevance of shadow banking differences greatly by country and region which makes monitoring or drawing inferences on global stability difficult.
• Complexity within the credit markets is high and it is not easy to see where there are current critical risks. There are a number of credit function categories and maps for describing financial intermediation.
• The FSB divides NBFI into five economic function categories: collective investment vehicles, lending entities based on short-term funding, financial intermediaries, credit creation facilities, and securitization.

Banking is still important but the financial intermediation in other forms and from other sources means that central banks have a hard time controlling rates, risks, and lending. The data shows that repo markets have increased in importance. The Fed may have thought there were enough excess reserves as of September, but in reality, the financial system is also driven by the flow of funds outside the banking system.

This stability report reinforces our ongoing theme that it is not the liquidity but the plumbing that is the potential problem area for finance. Bank capital has grown, and leverage has been controlled since the Financial Crisis, but shadow banking has continued. The regulatory rules of the game have also changed which impacts credit flows. 

Of course, this report tells us that the shadows are not as dark as before, but there are still a host of issues on the quality of lending, terms, and defaults that still are opaque. 

The next crisis issue will be similar to those in the past, a shortage of liquidity, the inability of borrowers and lenders to access cash in the margin, and contagion from not knowing whether capital will be repaid or who is creditworthy. It is not clear that buying Treasuries or just lowering rates will be able to solve these problems.