MNI INTERVIEW: Growing Spillover Risk Of Banks, NBFIs- Acharya

MNI (WASHINGTON) - The growing linkages between banks and non-bank financial firms are creating unidentified systemic risks that require greater scrutiny from regulators, ex-Reserve Bank of India deputy Viral Acharya told MNI.

Acharya, a member of the New York Fed's financial advisory roundtable, worries supervisors have yet to make a credible commitment to regulate nonbank entities that might one day receive official support -- or sought to significantly mitigate the moral hazards associated with the expectation of possible future bailouts.  

"The sort of organic symbiotic relationship between banks and non-banks is a more accurate description of the world than just saying nonbanks are either developing in parallel or substitutes to the banking system," said Acharya, also a former New York Fed resident scholar, in an interview. 

"This matters because when big shocks occur nonbanks typically can't raise financing" and "might inevitably become dependent on the banking system through credit lines."

HOLISTIC APPROACH

Officials at the Financial Stability Board and central bankers around the world have ramped up attention on risks from NBFIs, with some arguing international coordination is needed but reforms should be tailored and targeted because of the diversity of the sector. (See: MNI INTERVIEW: Coordination Needed On Non-Banks - Irish Deputy)

FSB Chair Klaas Knot earlier this week ahead of G20 meetings warned efforts to reform non-banks might be losing momentum and patchy progress on reforms to make money market funds and other types of NBFIs safer has left the global financial system vulnerable to more shocks. Officials have proposed strengthening margining and are now focusing on monitoring and addressing leverage, with proposals expected by the end of the year. 

Non-banks, which include insurers, private equity, hedge funds and other investment funds, now account for almost half of global financial assets.

BOLDER STEPS

Acharya applauded the FSB for its call for transparency of bank and nonbank linkages but said authorities need to take bolder steps, because risks are interwoven throughout the financial system and nonbanks are dependent on banks in crises. "There's loan origination, there's loan refinancing, there's not enough rollover financing available, and all of those stresses which are about flows, not stocks, are constantly reliant on the banking system," he said

It is incorrect to think squeezing risk out of banks through complex regulation is similar to squeezing a balloon, with risk merely bulging elsewhere, Acharya said. Instead, banks and nonbanks are more intertwined than ever in an interdependent system.

"We should not sit tight and happy about it because the liquidity is still going to be managed by the banking system and so the risks could have spill backs and then spillovers," he said. Acharya pointed to real estate investment trusts, which hold a very big piece of U.S. commercial real estate, being a particular risk and dependent on banking system credit lines.

ADDRESSING RISKS 

"You need to know how to stress test the banking system for these drawdowns that occur in the stress scenarios. At a minimum, they need to gather data on that. To the extreme, the idea would be that you put on the table something requiring non-banks to preposition collateral" and subject to regulation, he said. 

Regulators may wish to consider ex-ante measuring and monitoring of systemic risks, as well as inducing banks and NBFIs to internalize the systemic risks generated by their activities, Acharya said. 

The next steps, he said, would be to embed disclosures into stress test analysis of banks and non banks, in addition to resolving banks' interest rate risks and imposing a liquidity coverage ratio even on smaller banks.