The rise of non-bank financial intermediaries (NBFIs) has reshaped global finance, challenging traditional banking dominance and prompting urgent regulatory scrutiny.
Their expansion offers both opportunities and risks, demanding a careful balance between innovation and stability.
The rise of non-bank financial intermediaries
NBFIs ranging from hedge funds and insurance firms to pension funds and money market funds have surged in prominence. In 2023, the NBFI sector grew by 8.5 percent, more than double the 3.3 percent growth rate of the banking sector, raising the NBFI share of total global financial assets to almost 50 percent, approximately $250 trillion.
This growth was largely attributed to higher asset valuations and investor inflows.
Their appeal lies in funding diversification and regulatory arbitrage, yet this shift comes with systemic concerns. The rapid growth of NBFIs, often lightly regulated compared to banks, has amplified financial fragility, particularly during periods of stress.
The Financial Stability Board (FSB) has highlighted that the NBFI sector’s expansion has increased the complexity and connectivity within the financial system, posing significant risks to financial stability.
Liquidity management in NBFIs
Unlike banks, NBFIs lack direct access to central bank liquidity, making them reliant on short-term funding, commercial paper, and liquid asset buffers. This dependence exposes them to market disruptions, rate volatility, and investor sentiment swings.
For instance, the launch of private asset exchange-traded funds (ETFs) has raised concerns about liquidity risks during financial crises, as these funds may struggle with accurate pricing and redemption abilities in volatile markets.
To mitigate liquidity shocks, NBFIs employ stress testing, contingency funding plans, and liquidity buffers.
However, their resilience remains untested in extreme financial turbulence, raising concerns about contagion risks within the broader financial system. The FSB has recommended enhancing the monitoring and management of non-bank credit risks to address these vulnerabilities.
Prudential treatment and regulatory frameworks
Regulation of NBFIs varies widely across jurisdictions, creating challenges for global financial oversight. Some regulators impose capital and liquidity requirements, while others adopt a fragmented approach.
The lack of uniform rules heightens cross-border financial risks. The FSB has proposed measures to improve regulatory consistency and cross-border cooperation to mitigate these risks.
Macroprudential policies have been introduced to curb systemic threats, including leverage caps, stress tests, and enhanced transparency.
Yet, regulatory gaps persist, underscoring the need for coordinated oversight to prevent market destabilisation. The FSB’s annual monitoring exercises aim to identify vulnerabilities and initiate corrective actions where necessary.
Impact on the financial sector and economies
NBFIs contribute to financial innovation, diversify funding sources, and support capital market efficiency. Small and medium-sized enterprises (SMEs) and startups, often underserved by banks, benefit from alternative financing.
For example, in India, non-banking finance companies have requested the government to establish a liquidity facility to enhance lending to priority sectors, including agriculture and renewable energy.
However, their growing interconnectedness with the financial system raises systemic risk concerns. The 2008 global financial crisis highlighted the perils of unchecked shadow banking, prompting tighter scrutiny.
Despite reforms, vulnerabilities remain, particularly in highly leveraged sectors. The FSB has noted that the NBFI sector’s expansion has increased the complexity and connectivity within the financial system, posing significant risks to financial stability.
Global economic implications
The global footprint of NBFIs means their actions influence financial stability beyond national borders. Capital flows, cross-border lending, and investment strategies impact global markets, necessitating international regulatory cooperation.
The FSB has emphasised the need for regulatory consistency and improved cross-border cooperation to address these challenges.
The road ahead
As NBFIs continue to expand, regulators must strike a balance between fostering financial dynamism and safeguarding stability. Strengthened prudential frameworks, enhanced risk transparency, and systemic safeguards are essential to mitigate potential shocks.
The FSB’s ongoing monitoring and policy development efforts aim to enhance resilience in the NBFI sector.
While NBFIs play a vital role in modern finance, their unchecked growth could pose risks reminiscent of past crises.
A proactive, coordinated regulatory approach is necessary to ensure they contribute to financial resilience rather than systemic fragility.
Gift Duru, Bsc Mass Communication, MBA Digital Strategic Marketing, is a senior project Manager with over 7 years experience
