Unveiling the Hidden Giant: The Growing Dominance of Non-Bank Financial Institutions

The irony of the financial system’s largest ‘known unknown’

Regulation helped Non-Bank Financial Institutions surpass banks in size. They are an increasingly important competitor, source of funding and client to banks. But their vulnerability and lack of transparency create the largest "known unknown" risk for the banking sector. Regulation will take time. Meanwhile, central banks may be forced to help out.

 

Why you should know about NBFIs

Non-Bank Financial Intermediaries (NBFIs) have grown significantly since 2008 and as a result, the sector's influence has come under increasing scrutiny. Last year's UK gilt crisis was another wake-up call for regulators, with concerns rising over the growing vulnerabilities. Regulators across the globe are now asking for more and stricter regulation of these activities.

In contrast to NBFIs, banks have seen stricter regulation since the global financial crisis, leaving room for NBFIs to develop. However, in the face of the increasing complexity and interconnectedness of the sector, a severe shock to NBFIs could spread to banks, creating a new type of risk for the traditional banking sector.

 

NBFIs have many faces, including ones that can look like a bank

The term NBFI is used to describe a large variety of institutions. We are classifying them all as non-banks that take in cash and use it to generate a return. Most NBFIs take in cash, just as banks do, and deploy it in various securities and derivatives. The Financial Stability Board (FSB) monitors NBFI activity and divides the sector in two:

NBFIs not engaging in credit intermediation nor bank-like activities (about 75% of the sector).

All the entities which have bank-like activities, also called the “narrow measure”, where Money Market Funds and Fixed Income Funds make up the largest part (for other economic functions, see annex).

Another way of looking at NBFIs is simply by dividing them into the main components such as:

• Insurance Corporations (ICs)
• Pension Funds (PFs)
• Other Financial Institutions (OFIs), such as Investment Funds and Money Market Funds
• Financial Auxiliaries (FAs), such as insurance brokers and captive financial institutions.

 

Fast growth made NBFIs much larger than the banking sector

The stricter capital and liquidity requirements on banks put in place after the global financial crisis - notably through the implementation of Basel III - made some parts of lending less attractive for the banking sector. NBFIs were already present before 2008 but stepped in to take over portions of this business as regulatory requirements grew for banks. The IMF highlights that NBFIs have become a crucial driver of global capital flows for emerging markets and developing economies. Looking into the different NBFI components and sampling 21 major global economies and the euro area (list of countries in the annexes), the FSB reported strong growth for the sector in 2021, at 8.9% year-on-year. This is a significant development as the sector has seen average growth of just 6.6% over the last five years.

 

The NBFI sector has grown in every component since 2019 to reach $239.5tn

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