However, as the recent financial crisis has shown, the shadow banking system can also be a source of systemic risk, both directly and through its interconnectedness with the regular banking system. It can also create opportunities for arbitrage that might undermine stricter bank regulation and lead to a build-up of additional leverage and risks in the system. Enhancing supervision and regulation of the shadow banking system in areas where systemic risk and regulatory arbitrage concerns are inadequately addressed is therefore important.

The G20 Leaders at the November 2010 Seoul Summit asked the FSB to develop recommendations to strengthen the oversight and regulation of the shadow banking system. The FSB has since formed a task force to develop initial recommendations for discussion that would:

• clarify what is meant by “the shadow banking system”;

• set out potential approaches for monitoring the shadow banking system; and

• explore possible regulatory measures to address the systemic risk and regulatory arbitrage concerns posed by the shadow banking system.

The note sets out the current thinking of the task force - in particular on the first item. It proposes that monitoring and policy responses should be guided by a two-stage approach: firstly by casting the net wide to cover all non-bank credit intermediation so as to identify potential areas where new risks might arise; and then secondly by narrowing the focus to those parts of the system where maturity/liquidity transformation, flawed credit risk transfer, and/or leverage create important systemic risks.

Based on the work of the task force, the FSB will consider initial draft recommendations at its July Plenary meeting and thereafter the recommendations to be submitted to the G20 in the autumn.

Deadline for comments is 16 May 2011.