The shadow banking system was at the heart of the financial crisis. In the meltdowns of Lehman Brothers and AIG, the equivalent of bank runs afflicted money market funds, repo markets and securities lending. When panicked lenders pulled the short-term funds that backed financial groups’ long-term assets, borrowers could not sell holdings fast enough to meet the demand for cash.
Preventing a re-run of this spiral has been a central goal of lawmakers and regulators since 2008. They have cracked down on practices that allowed banks to build up leverage off- balance sheet, and to accumulate debt that boomeranged with dire consequences when markets seized up.
Now the Financial Stability Board has opened another front. For the first time, the regulator has set global rules on collateral for short-term lending. These impose minimum requirements on the collateral required when non-bank institutions borrow from banks against their assets. Many hedge funds and securities houses, for instance, finance their positions through the repo market – a type of financial pawnbroking where firms cash in assets with a promise to repurchase them later.