WASHINGTON — The 2008 financial crisis amply illustrated the potential for nonbank financial firms to pose a risk to the broader financial system. But the increasing growth and interconnectedness of those firms is compelling regulators to rely on the limited tools they have to check that risk.
Ian Katz of Capital Alpha Partners says regulators are keeping a watchful eye on the expanding connections between banks and the alternative asset management sector.
“I think this has been building gradually for a long time,” said Katz. “More financial activity has moved outside the banking sector in recent years, and a lot of that activity isn’t under direct federal oversight.”
Evidence from a Financial Stability Board publication in 2023 showed nonbanks’ market share has grown since 2008. FSB
“[Regulators] believe that non-banks don’t operate under the same tough regulations they face, and it’s a fair point that banks are regulated more strictly than non-bank financials,” Katz wrote. “At the very least, the bank regulators want to keep the riskiest and sketchiest stuff away from the banks they oversee.”
Regulators’ strongest tool to rein in risks from nonbanks is housed with the Financial Stability Oversight Council, an interagency commission created by Dodd-Frank tasked with identifying and curtailing risks to the broader financial system.
While its power to designate nonbanks systemically risky — thereby subjecting such firms to enhanced prudential standards similar to those big banks face — was weakened through
“There doesn’t seem to be an indication that the FSOC is working on entity designations in regards to the asset management industry,” said Portilla.
While entity-level designations don’t appear imminent, Katz notes that regulators still can exercise some limited indirect power to hedge risks from nonbanks.
“What they can do is have some influence indirectly,” Katz wrote in an email, “by increasing scrutiny or tightening rules around who banks can do business with [or] what they can have on their balance sheets.”
Indeed, federal regulators have been floating a variety of new policies related to nonbanks over the past year. Federal Reserve Vice Chair for Supervision Michael Barr
Another top regulator, acting Comptroller of the Currency Michael Hsu, recently
Additionally, Federal Deposit Insurance Corp. Chairman Gruenberg
Treasury’s Financial Crimes Enforcement Network also
Harry Stahl, director of business and solutions strategy at FIS — a leading regulatory technology provider to the nonbank industry — notes the nonbank sector has noticed the spotlight shining on their industry and reacted accordingly.
“There’s a lot more sense of thinking about who are the players in the ecosystem and making sure that everybody is well organized, buttoned down and complying with the critical regulatory concerns,” said Stahl. “It’s not surprising that this would be happening now when we look at what’s going on in the market.”
Bryan Corbett, president and CEO of the Managed Funds Association — a trade association that represents asset management firms like hedge funds — argued that nonbanks are less systemically risky and already sufficiently regulated. Unlike banks, he said, their funding is not subject to the same kinds of run risk, and the capital such nonbank firms manage comes from institutional investors and is locked away for some time.
“FSOC’s SIFI designation and other attempts to apply banklike regulation to private funds is misguided and will harm U.S. capital markets,” Corbett said. “There is already a robust regulatory regime in place for alternative asset managers that grants regulators insight into the activities and health of funds and the tools to ensure the market is well regulated.”
Banks have appeared to seize on uneasiness about growing influence of nonbanks to argue against the Basel endgame
“The regulators trying to get their arms around nonbank activity does respond to the criticism that the Basel endgame pushes activity outside the regulated banking sector,” he wrote. “I think that’s one of the criticisms of Basel that the regulators view as valid.”
Dennis Kelleher, CEO of consumer watchdog Better Markets, said he is equally concerned with less-regulated nonbanks increasing financial services intermediation. However, he argues the solution is not to ease up on banks, but regulate banks and nonbanks alike to prevent regulatory arbitrage.
“If the nonbank sector is not regulated, that’s no reason to also not regulate the banking sector,” Kelleher said. “That would be doubling down on disaster and guaranteeing a catastrophic financial crash like or worse than 2008. Strengthening the banking sector is only half the battle of preventing financial crashes, contagion and bailouts, as proved in 2008, 2020 and 2023.”