EU watchdog warns of ‘black holes’ in shadow banking system

London — Regulators seeking to map out risks from the booming nonbank financial industry face information “black holes” that might be fixed only by mandatory disclosure, according to the chair of Europe’s banking watchdog, but the process could take years.

Nonbank financial institutions, including hedge funds, private credit providers and insurers, accounted for $218-trillion, or just under half, of the world’s financial assets in 2022, according to the Group of Twenty’s Financial Stability Board (FSB).

The shadow banking sector’s rapid expansion is a growing priority for regulators, who worry about its lack of transparency and the degree to which its problems could threaten the resilience of broader financial markets.

European Banking Authority chair José Manuel Campa said he feared much of the system could remain out of global watchdogs’ sight, making “some kind of reporting requirements” for shadow banks a potential “next step”.

“My sense is that as we map, we will have difficulties identifying the information. There will be black holes because at this stage, there are no regulatory reporting requirements,” Campa said.

Building up reliable and comprehensive data is crucial to making the case for new rules governing nonbank lending. Private credit lenders are increasingly the go-to financiers of companies that struggle to raise money from mainstream banks.

Research from the Alternative Credit Council (ACC) estimates that private credit fund managers lent about $333bn in 2022, up 60% from $200bn disbursed in 2021.

But the 2021 collapse of private investment fund Archegos Capital Management illustrated just how deeply the core banking system could suffer from troubles stemming at nonbanks, causing big losses at ill-fated lender Credit Suisse.

Understanding banks’ direct exposure to nonbank counterparties was relatively easy, and the size and type of these exposures had so far given no cause for alarm, Campa said.

But regulators tended to “lose track” when they attempted to follow that money further and learn more about what private lenders were doing with capital borrowed from regulated banks.

“I think that engaging with major asset management companies or major private equity funds is much easier than engaging with some of these hedge funds that are more private. This is a very diverse ecosystem,” Campa said.

Regulators have said it may be some time before firm decisions on how to supervise nonbank activity are made, with global consensus necessary to implement international rules for such a cross-border industry.

The FSB later this year plans to reveal the findings of a big exercise to gather data on nonbanks and their ties to regulated lenders. The Bank of England is also seeking to build a case for new rules based on findings from its first sector-wide stress test.

FSB secretary-general John Schindler said in December regulators were aiming to sketch out policy proposals on tacking leverage used by shadow banks by the end of 2024 or early 2025.

“What is delivered towards the end of the year will be better than what we have,” Campa said.

Reuters