Global Bank Review 2024
Adaptation: Change is the only constant
23 Jan 2025
Insight
Global
7m read
Place the financial sector under the microscope and what do you see? Banks and public exchanges will quickly come into focus dominating the environment. However, look closer, and you will see other things moving in the in-between spaces of the ecosystem.
Non-bank financial intermediation (NBFI) – the new, more representative and less pejorative term for 'shadow banking' – comprises investment funds, insurance companies, pension funds and a vast array of other financial intermediaries. They offer alternatives to traditional bank lending, presenting opportunities for investing and for raising capital; these institutions direct huge flows of private capital and play a major role in financing the real economy.
Since the 2007/08 financial crisis, NBFI has grown rapidly - speaking in 2024 ECB Supervisory Board member Elizabeth McCaul highlighted global growth from €87 trillion in 2008 to €200 trillion in 2022 (approximately US$91 trillion to US$210.15 trillion). There is, of course, variation among jurisdictions, with the US consistently ahead, although some other jurisdictions boast higher proportions of NBFI investment to total financial assets.
In a nutshell:
There is a perceived gap in regulatory oversight of non-bank financial intermediation (NBFI) which remains largely unresolved despite increasing attention. As the final post-global financial crisis banking reforms approach implementation and the search for growth becomes increasingly competitive at a global level, regulators will be under growing pressure to act more holistically on NBFI.
The current regulatory landscape is an inconsistent patchwork; coordinated effort at a global or at least regional level is needed to alleviate uncertainty for NBFI institutions, traditional banks, investors and investees, and to mitigate risk to the real economy.
Given more recent regulatory discourse, action will no doubt be imminent but there is still a question of what form this will take. Regulators face many choices – will they opt for a single piece 'NBFI regime' or, given the variety of institutions concerned, a jigsaw puzzle of interlocking regimes?
At long last, it looks like there is a real will to address the lacunae in regulatory oversight of NBFI – but the situation is fragile and subject to how political winds blow in the near to mid-term.
Michelle Virgiany
Senior International Counsel, Jarkarta
Regulators at a cross-roads
The NBFI regulatory landscape is a patchwork – varying by jurisdiction, by type of institution, by activity and more. Navigating this is overly complicated for NBFI institutions, traditional banks, investors, investees and the regulators themselves. This patchwork stands in high-definition contrast to the more comprehensive and harmonised frameworks that have developed in relation to banking, including those elements introduced in response to the 2007/08 financial crisis.
Regulators have long recognised the difference in the way traditional banks and NBFIs are treated. Concrete, coordinated action has been slow to follow. However, the FSB has recently released proposed policy measures to address leverage in NBFI for consultation. With many of the post-GFC reforms in place and the Basel 3 banking reforms nearing completion, the regulatory community is now putting a tentative foot on the road to NBFI regulation. With discussion around intervention increasing, reform appears to be imminent – the question is no longer 'when?', but 'what form?' regulation will take.1
Harnessing the advantages of NBFI
For some time, it has been generally held that NBFI can reduce reliance on traditional bank lending, diversify sources of capital and investment opportunities, and thereby create a healthier, more balanced economy; the US economy is frequently highlighted as an example. This has informed certain public policy interventions – for example, the new UK Government's proposed radical pension reform includes the creation of consolidated pension 'megafunds' for UK investment. This is part of the wider narrative to prioritise economic growth and, in the case of the financial services industry, to recalibrate the guardrails on risk-taking to revitalise London as a financial centre. What was once viewed as regulators 'wrapping their arms around an issue' is now perceived to have become a chokehold from which growth needs to be released.
Risks – Regulation behind the curve
Conversely, as NBFI reshapes the financial sector and the real economy, it carries risks.
Recognising the rapid growth in private credit markets, IOSCO undertook a thematic analysis of the emerging risks in private finance in 2023. In its report, the important functions that the private credit market could play was recognised. However, the report also pointed to a lack of transparency that means that potential risks can not readily be assessed by regulators or investors. The noted risks include conflicts of interest, interconnectedness with the wider financial system and the impact of macro-financial developments on the sector.
The current regulatory patchwork for NBFI is a source of uncertainty for NBFI institutions, banks, and investors. Keeping track of what the requirements are will be a challenging task.
Lisa Fried
Partner, New York
The FSB regularly reports on NBFI trends and systemic risks; it also makes recommendations to policy makers and regulators. High-profile NBFI failures are illustrative of a regulatory lacuna - Archegos and Woodford are recent cases in point where material investor losses have crystalised. In addition, a recent exercise by the Bank of England found that NBFI risks amplifying shocks across the market. Such institutions are vulnerable in a crisis due to limited access to funding and this carries the risk of fire sales. Critically, governments and regulators do not (yet) have the full picture of the NBFI ecosystem. This includes what is happening at a macro level and how NBFI is impacting/re-shaping the overall market environment. This in turn makes potential market failure difficult to spot and proactively address.
How are regulators responding?
UK
At a prudential level, the UK Prudential Regulation Authority (PRA) has sent cautionary messages to the market, and expressed a potential willingness to regulate around banks' exposures to NBFIs. It has been vocal about the perceived lack of transparency with private equity markets in terms of their complexity and interconnectivity and the need to build resilience.
The UK Financial Conduct Authority (FCA) has acknowledged the need to enhance the regulatory framework, but at the same time, Nikhil Rathi, the FCA's current CEO, has cautioned against overreaction. Mr Rathi called for an "enabling and proportionate regulatory approach" that recognises the big opportunities NBFI carries. As an immediate step, this involves more transparency and collecting better data from firms 'to build a system-wide picture of risks'.
EU
As NBFI accounts for approximately €42.9 trillion assets or circa 41% of the EU financial sector's assets, EU regulators have similar concerns and are adopting measures which facilitate risk mitigation, investors' protection, and transparency improvement.
There are a number of elements in the existing cannon of EU regulation which address NBFI, including the UCITS Directive, Alternative Investment Fund Managers Directive, the European Market Infrastructure Regulation (EMIR), Solvency II, and the Investment Firms Prudential Directive and Regulation (IFPD/R). However, there is currently no overall macroprudential framework, and this aspect is the current focus of work by the European Commission; having consulted in the 2024, the development of legislation is firmly underway.
A single regime for NBFI sounds attractively simple, but given the diversity of the sector, crafting a 'one-size-fits-all' regime will be a significant challenge for regulatory policymakers.
Michael Tan
Senior Associate, London
Hong Kong
The Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority (HKMA) have been monitoring the risks from NBFI, and have surveillance systems in place for this purpose. The HKMA adopted its NBFI surveillance framework in 2021 as part of its regular financial stability surveillance toolkit, which has (among other things) flagged a number of highly leveraged NBFIs (hedge funds and family offices) as having hidden vulnerabilities and risks.
The Chief Executive of the HKMA, Eddie Yue, has stressed the importance of strengthening the resilience of NBFIs and reducing their procyclicality in times of system-wide stress, and the HKMA has also noted the money laundering and terrorist financing risks brought about by the activities of NBFIs in new and emerging sectors, including crypto. The SFC's CEO, Julia Leung, has recently stated that "private credit should be supported as an alternative form of financing for enterprises and projects with a longer investment horizon, but there should be adequate transparency and liquidity risk management, as well as more data reporting.
Indonesia
For years now, the Financial Services Regulatory Authority (Otoritas Jasa Keuangan, or OJK) and the Central Bank (Bank Indonesia, or BI) have tried to maintain the balance between supporting the growth of NBFIs to increase financial inclusion and managing the risks that NBFIs (including their failures) pose to consumers and the stability of the financial systems.
More recently, OJK has been revising and consolidating the regulations that are applicable to NBFIs, with more features resembling those found in the banking regulatory frameworks, in an effort to strengthen their resilience. In its 2030 Payment System Blueprint, BI highlights the importance of strengthening the link between banks and NBFIs to mitigate the risks of shadow banking and outlines strategies that will be implemented in the payment sector moving forward.
Australia
While not regulated as a discrete sector, NBFIs operating in Australia are subject to a range of regulatory measures, as described in our recent article. However, Australian regulators have similarly recognised the growth of the NBFI sector and the need to understand it. Part of ASIC’s recent corporate plan is to drive consistency and transparency across markets and products. As part of this strategic priority, ASIC is undertaking thematic reviews including of private finance funds and considering their governance, valuation practices, management of conflicts of interest, staff and insider trading, protection of confidential information and fair treatment of investors.
At the same time, the Reserve Bank of Australia (RBA) is focussed on ensuring that the private credit market in Australia is understood in order to properly assess the risk associated with it. As part of its recent review on the sector, the RBA has stated that while global private credit has growth rapidly, the risks to financial stability currently appear contained but will continue to be monitored.
US
The Federal Reserve Bank (Fed) acknowledges that the largest banks it supervises have substantial connections with NBFIs and that monitoring those exposures is critical for effective bank supervision. The Fed and other agencies work through the Financial Stability Oversight Counsel to monitor whether NBFIs might pose a threat to US financial stability and therefore ought to be subject to Federal Reserve supervision.
The regulatory outlook for NBFIs remains unclear, however. For example, the SEC in late 2023 adopted new rules under the Investment Advisers Act of 1940 to enhance the regulation of private fund advisers and update the existing Advisers Act compliance rule that applies to all registered investment advisers. These rules required registered advisors, among other things, to prepare private fund quarterly statements including detailed information regarding fund performance and adviser compensation. But in June 2024, the US Court of Appeals for the Fifth Circuit vacated those rules, only one of which had taken effect in advance of the Fifth Circuit’s decision. Recent US Supreme Court precedents in the field of administrative law, disapproving of historical judicial deference to administrative agencies, may make additional broad regulation less likely, and under the Trump Administration, the SEC and other federal agencies may take a different approach to regulating NBFIs.
A growing clamour
Having circled the issue of NBFIs for the past decade, regulators are finally homing in on the issue and we can expect movement in this space. The key question is: what will this look like? Regulators are recognising the need to address prudential concerns about financial stability and the need to build resilience as well as conduct concerns. At the same time, governments are keen to harness the investment opportunities that NBFI opens up, particularly in a difficult economic environment.
The difficulty for all lies in how to walk the middle course. It is a case of the classic regulators' dilemma when faced with innovation or change where they are behind the curve in terms of data and understanding. Overregulation carries the risk of stifling growth. Under-regulation carries the risk of (potentially catastrophic) market failure.
In the meantime, many regulators are scrambling to play catch-up to close the knowledge and data gaps and they view that information-gathering exercise as imperative to developing a coherent and rational regulatory approach.
Footnotes
1 See for example Ashley Alder's Bloomberg Buy-side Forum Speech (May 2024) on the agenda for UK asset management.
Key contacts
Chapters
- Global FSR Outlook 2025: Perpetual Motion
- The long and winding road of regulatory overhaul
- Adopt, adapt, improvise – The new regulatory approach?
- Many roads lead to Rome: Paths to redress and remediation
- The sanity of crowds – Can smart data initiatives transform consumer finances?
- Juggling water – How to regulate AI in financial services?
- Teetering on the brink of quantum utility – Not if, but when ...
- Rewiring the infrastucture – Making transactions faster
- A growing clamour – Can NBFI get out of the shadows?
- The anxiety of ageing – What changing demographics mean for financial services
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© Herbert Smith Freehills 2025
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