## Foreword

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### Overview and context
- Strengthened supervision and regulation, better crisis management preparedness and resolution processes, enhanced data collection, and a macroprudential approach to financial sector oversight have raised the financial sector’s resilience to recent shocks.
- The structure of the global financial system is undergoing substantial transformations, most notably with the growing participation of nonbanks in financial intermediation (NBFI).

### Drivers of NBFI growth and structural change
- Constraints imposed by postcrisis regulations on banks’ leverage have encouraged diversification and the transfer of risk to other financial intermediaries.
- Pension funds, insurance companies, and sovereign wealth funds have grown from 50 percent of global GDP to close to 90 percent over the past two decades, with much of their assets deployed to nonbanks.
- New digital technologies are revolutionizing distribution of financial services, credit evaluation, trading, and market making.

### Benefits of market-based finance and NBFI
- Market-based finance and nonbank credit intermediation have generated alternative sources of financing for firms, better capital allocation, and greater market efficiency through capital markets activity, private equity and private credit, hedge funds, and high-frequency market making and trading.
- A broader set of financial intermediaries with different risk profiles, time horizons, and expertise:
  - avoids overreliance on banks;
  - increases competition;
  - provides diversification to borrowers and investors; and
  - creates mechanisms for risk transfer away from the banking system.
- Benefits are unevenly distributed; many advanced, emerging market, and developing economies remain bank-centric and could benefit from further development of NBFI and market-based finance.

### Risks, recent episodes, and the need for policy action
- Past GFSRs identified vulnerabilities from liquidity mismatches in open-ended mutual funds, highly leveraged trading strategies used by hedge funds, and opaque interconnectedness in the broad NBFI sector.
- As nonbank financial institutions become vital to intermediation in core markets (government and corporate bonds), availability of market liquidity in times of stress has come into question, sometimes requiring central bank intervention.
- International standard setters are making progress to enhance NBFI resilience; continued expeditious progress and timely, consistent national implementation are paramount.
- Elevated economic and policy uncertainty and rising geopolitical risks increase downside risks to future growth, asset prices, and bank lending (see Chapter 2). Uncertainty can trigger cross-border spillovers through trade and financial linkages.
- The August 2024 turmoil illustrates the challenge: when volatility spiked, many leveraged investors reached risk limits, faced increased margin calls, and rapidly closed positions, which helped protect individual institutions but likely exacerbated the sell-off through nonlinear effects.

### Thinking through the “future of finance”
- Technological innovation can increase efficiency and competition while disrupting bank-provided services.
- Novel lending modalities for private credit are likely to continue growing; artificial intelligence may support further growth in NBFI (see Chapter 3); digital banks are growing in systemic importance.
- Prudential regulation of nonbanks has traditionally been absent or less strict because they do not take deposits from retail investors and largely lack recourse to central bank backstops. As NBFI grows and links with banking increase, more substantive externalities may arise, potentially requiring novel policy approaches.
- Regulation and supervision of NBFI need to consider broader financial stability objectives and the trade-offs between protecting institutions and creating systemwide nonlinearities.

### Policy priorities and recommendations
- Expand data collection:
  - Collect more comprehensive data on NBFIs to evaluate risks to global financial stability and map interlinks.
  - Obtain information on use of leverage and asset holdings to develop effective policies addressing systemic risks without stifling innovation.
- Increase transparency:
  - Address opacity of nonbanks and improve information to investors and the public.
  - Strengthen conduct requirements and public disclosure to support market discipline and price discovery, particularly given increasing retail investor participation.
- Design appropriate liquidity facilities and backstops:
  - Recognize that liquidity stress in NBFI can spill over to the broader financial sector (e.g., the March 2020 dash-for-cash).
  - Central banks may face trade-offs between short-term support to safeguard financial stability and introducing moral hazard.
  - During periods of high inflation and monetary tightening, central banks may also face trade-offs between financial and price stability mandates.
  - Develop mechanisms for central bank support that minimize moral hazard and encourage nonbanks to internalize liquidity risks.
  - Prepare communication plans to avoid perception that central banks are working at cross purposes (for example, purchasing assets to restore financial stability while tightening monetary policy to fight inflation).
- Improve the financial “plumbing”:
  - Ensure payments and settlements systems operate effectively and securely in stress.
  - Promote interoperability across systems and platforms, especially cross-border.
  - Integrate new technologies, including artificial intelligence, to enhance efficiency and security.
- Enhance resilience of central counterparties (CCPs):
  - Ensure CCPs have enough resources to cover potential losses.
  - Maintain business continuity plans and clear recovery and resolution plans for restoring stability or winding down.
  - Review margining requirements to protect CCPs while considering broader system impacts of margin and collateral calls during stress.
- Undertake a systemic approach to NBFI resilience:
  - Recognize that NBFI vulnerabilities can amplify shocks with systemic implications (e.g., bond fund liquidity mismatches, large margin calls in derivatives, failures of highly leveraged nonbanks such as Archegos).
  - Address the gap where prudential frameworks are often institution- or sector-specific and lack system-wide, cross-sectoral perspectives.
  - Coordinate relevant authorities to ensure governance, monitoring mechanisms, and processes to assess NBFIs from a systemic perspective.
  - Sharpen existing tools and potentially develop new tools to address systemic risk.

### Summary conclusion
- The core ask is to enhance the prudential framework to address systemic risks from a larger NBFI sector while recognizing that leverage facilitates financial intermediation and interconnectedness enables efficient capital mobility and allocation—the core role of the financial sector.
- The IMF stands ready to continue working with member authorities, international financial institutions, and global standard-setting bodies to achieve these goals.

*Foreword, Tobias Adrian, Financial Counsellor*

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_Source: https://www.imf.org/-/media/files/publications/gfsr/2024/october/english/foreword.pdf_