Non-banks encompass a wide range of business models, including pension funds, insurers, hedge funds, and many others. The activities of these firms are vital for the financial health and growth of the UK economy.
Therefore, making sure these firms are resilient and financially stable ensures they provide consumers and businesses with the services they need – in both good times and bad.
Non-banks use leverage (borrowing to invest) to increase exposure, boost returns or hedge potential losses. This can be achieved in various ways, ranging from taking out loans to using complex derivatives. The use of leverage is an essential component of the deep and efficient capital markets that we have in the UK.
In good times, this leverage provides extra liquidity to the system and helps maximise returns. But in periods of market stress, leverage that is poorly managed, concentrated, or hard to spot can raise instability. This is particularly true in markets that are core to the functioning of the real economy. For example, UK government debt markets, or when highly leveraged non-banks risk transferring stress to institutions like banks, which are central to the stability of the financial system.
As the regulator, our role is to ensure that markets work well. Leverage is not inherently a cause for concern. But to ensure that leverage can continue to play its part in supporting the UK economy in good times and bad, we need to find ways to identify and address systemic risks - without impeding market efficiency or disproportionately burdening firms.
FSB recommendations
Two years ago, I took up a role as co-chair of the Financial Stability Board's (FSB’s)[2] working group on non-bank leverage. This group recently published policy recommendations (PDF)[3] seeking to identify and address financial stability risks created by non-bank leverage.
Effective risk management depends on having the right information at the right time. Without it, both market participants and regulators are essentially flying blind. The report addresses this fundamental challenge by recommending stronger risk monitoring and greater market transparency.
The proposed measures put forward by the FSB focus on improving how firms share critical information – both publicly and with their trading partners. These measures should give firms better insight into their own exposures and broader market conditions, helping them manage investment risks more effectively. The improvements should also provide authorities with a comprehensive view of the entire system. Having this birds-eye view enables authorities to spot risks that individual firms might not see – such as dangerous concentrations of investments or overcrowded market positions.
The FSB report also provides policy options for authorities to consider once they address risks to financial stability. Given the complex and diverse nature of the non-bank sector, there's no one-size-fits-all approach – so the report sets out a number of different alternatives that authorities may wish to consider. This approach is a good one - what matters is that all jurisdictions have sufficient measures to manage systemic risk, even if different authorities choose a different set of policy tools or measures to do so.
What's next for the UK?
We are already working to become a smarter regulator, and we're focusing on how we collect and use data to spot risks early.
To do our job, which is to make sure that markets function well, we know we need data that provides the practical insights we need to make effective, proportionate decisions.
The FSB recommendations are well timed for us. We are already taking steps to evaluate what data we need and switching off regulatory reporting returns that are no longer relevant. There is an ongoing programme of work looking at our data needs – and we’ll think carefully about which risk metrics are most useful for us going forward, including how we can align with other jurisdictions.
Working with our international partners
As much of the non-bank sector operates across borders, it’s crucial that we also collaborate with our international counterparts to spot risks and potential spillovers effectively.
This means engaging bilaterally on issues like information sharing and risk monitoring, while continuing to take an active role in international standard-setting bodies. In this way, we can strive for internationally consistent outcomes and be confident that we’re safeguarding the system, while still ensuring that the UK remains competitive.
My time leading this FSB working group has highlighted that non-bank leverage is a particularly tricky issue to tackle, demanding in-depth knowledge, industry perspective, and extensive international cooperation. The publication of the FSB’s recommendations is a major step forward in this space – and I’m proud that the FCA has been able to play such a leading role in advancing this work.