Speaking before German Finance Ministry and Bundesbank officials earlier today, Federal Reserve Vice Chairman Stanley Fischer warned his audience that non-bank are less vulnerable than they were during the global financial crisis, but now is not the time to relax.
“Regulation is a ‘cat and mouse’ game,” said Fischer. “Regulators need to respond to existing regulatory gaps and to keep pace with further changes. We hope we will succeed in doing so. But we know that we will never be able to identify in advance all of the threats to stability that are out there.”
The dearth of non-bank data hampers regulators from monitoring the stability of financial institutions and the financial system effectively, he added. “Outside of the banking system, we have only limited information on leverage and maturity transformation rather than precise estimates for all types of non-bank entities.”
However, Fischer has seen an increase in the volume of data that the Fed receives, but the central bank still needs to know the scope and size of hedge-fund and other non-bank activities.
“We need to be alert to changes and trends in the financial system that may pose risks to financial stability, particularly those stemming from areas of the non-bank sector that are not subject to prudential supervision,” he explained.
Fischer cited mutual funds that track the return on leveraged loans, credit default swaps, and other less liquid assets as an example. “These funds offer daily or even intraday liquidity to investors while holding assets that are hard to sell immediately, thus making the funds vulnerable to liquidity risk.”
This maturity transformation remains a key vulnerability as many non-bank financial firms rely on the secured short-term funding markets to finance their activities, according to Fischer.
“Many of the firms that rely on this maturity transformation are highly leveraged and thus more vulnerable to threats to their solvency. The proposed international framework being developed by the Financial Stability Board for margins on securities financing transactions may be an important tool for limiting the pro-cyclicality and sharp deleveraging that can occur in these markets.”