LONDON The $60 trillion "shadow banking" sector has been given until 2015 to fully comply with its first set of global rules, after an international regulatory task force unveiled plans to curb risk without strangling economic recovery.
Leaders of the group of 20 economies (G20) meet in Russia next week to endorse the rules written by their Financial Stability Board (FSB), setting out requirements for the sector and how it must be supervised.
The FSB will report on progress to the G20 next year with formal checks on compliance starting that year.
Shadow banking takes in a variety of financial intermediaries and remains a source of systemic risk for taxpayers after the 2007-09 financial crisis revealed "fault lines" that resulted in mainstream lenders needing public bailouts.
The reforms include supervisors collecting detailed data on the different parts of the sector to identify the broader risks.
National regulators must also be equipped with a set of tools to allow measures such as the imposition of capital and liquidity requirements or temporary limits on how much cash clients can pull out to avoid the destabilizing "runs" on money market funds seen during the crisis in the United States.
The rules are designed to curb excessive risk-taking by a sector that does not have access to central bank support or safeguards such as deposit insurance and debt guarantees. However, the FSB has sought to balance its proposals with the need to avoid harming an industry that is vital to financing the economy.
The European Union, meanwhile, publishes its own roadmap next week and has signaled that it may go further than the G20 rules and impose mandatory capital requirements on the sector.
Governments have already forced mainstream banks to hold more capital and FSB Chairman Mark Carney said the latest reform is an essential first step in transforming shadow banking into sound market-based financing.
"This in turn will help diversify the sources of financing of our economies in a sustainable way and contribute to the G20's ultimate objective of strong, sustainable and balanced growth," added Carney, who is also Governor of the Bank of England.
Daniel Tarullo, an FSB member and a governor at the U.S. Federal Reserve, said the rules were necessary because the tighter leash on banks may encourage risky operations to move to sectors with less stringent regulation.
The FSB said the focus is mainly on identifying shadow banking activities rather than individual businesses - a change of tack from the approach taken with big banks and insurers.
The G20 summit is set to endorse tougher rules for nine named insurers, as it has done for nearly 30 big banks, but a comparable hit-list of shadow banks has not been outlined.
Shadow banking activities that have been targeted include credit investment funds, exchange-traded funds, credit hedge funds, private equity funds, securities broker dealers, credit insurance providers, securitization and finance companies.
There would be curbs on brokers' re-use of their customers' assets for other transactions, a lesson from the collapse of Lehman Brothers which left regulators unsure about who owned what.
Despite the FSB's softly-softly approach, the reforms are certain to raise the hackles of some within the industry.
The FSB has decided to press ahead with plans to set the world's first minimum discounts, known as "haircuts", on the value of collateral to back repurchase, or repo, transactions and securities lending to ensure a big enough cushion if market valuations plunge.
The repo market involves borrowers selling the lender a security as collateral and agreeing to buy it back later at a set time and price.
Industry players including BlackRock and the International Securities Lending Association have said that minimum haircuts - which could be set at anything between 0.5 percent and 7.5 percent - could disrupt markets at a time when funding is needed to put sluggish economic recovery into a higher gear.
The warning has been heeded by the FSB. To soothe concerns the rule has been put out to consultation and it won't be finalized until next year.
The FSB said government debt would be exempt from haircuts, but the industry said the new rule would still create problems.
"This is not helping real economy financing as corporate bonds will be subject to a haircut. Only some corporate bonds are cleared so it adds costs to real economy financing which is not good at this time," said Godfried De Vidts, chairman of the European Repo Council, an industry body, on Thursday.
Actual implementation won't start until market conditions are right and authorities and industry have enough time to adjust their systems, the FSB said.
Regulators are also finalizing new curbs on links between mainstream banks and shadow banking participants, though the FSB has not set a date for their introduction.
(Editing by David Goodman and Tom Pfeiffer)