The Basel Committee on Banking Supervision has launched a consultative document to strengthen the shadow banking system and mitigate systemic risks.

Protecting banks from shadow bank problems

The document sets out a framework for identifying and managing step-in risk, which is the risk that “a bank might support unconsolidated entities, beyond any contractual obligation, in order to protect itself from any reputational damage arising from its connection to such entities”. If not appropriately anticipated, the materialisation of step-in risk could erode a bank's capital and liquidity position, according to the committee.

The shadow banking system refers to lending by entities not subject to regulatory oversight, or unregulated activities by regulated institutions. It can refer to hedge funds, unlisted derivatives and credit default swaps by regulated institutions.

Prevent spillover problems from shadow banks

According to the committee, the proposed framework will help to mitigate potential problems at shadow banks from spilling over to banks. It states: “This work is part of the G20's initiative to strengthen the oversight and regulation of the shadow banking system with the aim of mitigating systemic risks, in particular, those arising from banks' involvement with shadow banking entities.”

The revised framework is now open to a 60-day consultation period, although the committee does not envisage significant changes to the revised framework, which it views as near-final. Comments from the public can be made on the proposals by 15 May 2017 using the following link.