European Central Bank President Christine Lagarde has recently renewed her call to extend greater regulatory scrutiny over non-bank financial intermediaries—hedge funds, private equity, credit funds, and other “shadow banking” actors—that currently enjoy lighter oversight than banks.
Given the structural growth of these actors and their increasing links to the banking system, Lagarde warns of an uneven playing field, hidden systemic risk, and possible future crises. Her message is clear: if risks build outside the regulated perimeter, monetary policy may be forced to plug the gaps.
From the vantage point of financial inclusion and fintech innovation, this is a double-edge sword: stronger oversight may reduce destructive risk, yet overreach may stifle novel intermediaries reaching underserved populations. Below, I dig into why this shift matters, how the lessons from A.V. Bhatia bear on today’s debate, and what policy design should heed to preserve inclusion while safeguarding stability.
The context: non-banks now represent systemic weight
Lagarde’s argument is rooted in empirical shifts. In Europe, non-bank financial assets now account for something like 350 % of GDP—a scale that dwarfs many national banking systems. Because these entities don’t take retail deposits, they often escape prudential requirements (capital, liquidity, resolution).
Lagarde frames her proposal not as loosening bank rules, but leveling up regulation of non-bank actors that operate in bank-like ways or interlink heavily with banks. She also warns against “regulatory fatigue,” the complacency that tends to creep in after long periods without crisis.
The risks she targets include liquidity stress, runs, interconnectedness contagion, leverage amplification, and the possibility that central banks must step in as a last resort.
Her push is in part fuelled by historical memory: after the 2008 crisis, many vulnerabilities were traced to growth in the shadow banking system that escaped oversight.
Revisiting Bhatia’s pre-crisis diagnosis
To interpret today’s moment, A.V. Bhatia’s 2007 IMF working paper New Landscape, New Challenges is strikingly relevant. Bhatia documented, well before the global financial crisis, how U.S. finance was morphing into market-based intermediation, shifting risks into the “shadow banking” domain.
Key insights from Bhatia
- Rapid expansion and dominance of nonbanks
Between 1990 and 2007, non-deposit-taking institutions (broker-dealers, SPVs, funds) grew sharply, in some measures eclipsing traditional banks in size and influence. Bhatia notes the shift in credit intermediation from banks to capital markets as financial innovation matured. - Fragmented regulation, “gaps and overlapping coverage”
The regulatory architecture was (and remains) patchy: many nonbank entities were subject to varying regulators with jurisdictional blind spots. Bhatia warned that “structural change has outpaced the evolution of oversight”. - Opacity, leverage, and contagion risk
Financial innovation — securitization, derivatives, off-balance sheet vehicles — diluted the connection between underlying credit risk and who bears it. Bhatia cautioned about procyclicality and cascading stress in funding markets. - Call for function-based regulation
He urged that supervision be based on function (what entities do), not on legal forms (banks vs nonbanks). In short: if a hedge fund or fund manager acts like a bank or credit intermediary, it should face similar regulatory obligations.
Many of Bhatia’s warnings anticipated the post-2008 reforms — the rise of macroprudential regulation, the Financial Stability Oversight Council (FSOC) in the U.S., the push for shadow banking oversight (Adrian–Shin, Pozsar et al.), and cross-jurisdictional coordination.
Lagarde’s current call is, in effect, a reaffirmation that Bhatia’s red flags remain alive—and that regulatory regimes must evolve yet again.
Why this matters for financial inclusion and fintech
From a financial inclusion lens, nonbanks and fintechs often operate in the “gap zones” that traditional banks avoid: microcredit, supply chain finance, embedded finance, alternative credit scoring, digital micro-savings, and risk pooling. These niches thrive precisely because regulatory costs are lower, agility is higher, and innovation is freer.
But this flexibility comes with risks: misaligned incentives, fragile liquidity models, over-leveraging, lack of transparency, and vulnerability to sudden withdrawal. In a stress event, these risks can ripple into the broader system.
Stricter regulation of shadow financial actors could lead to:
- Reduced appetite for experimentation: Startups might avoid complex cross-border models or new credit constructs if compliance burdens are heavy.
- Higher capital or liquidity buffers: They may disproportionately affect small or early-stage firms with thinner margins.
- Barrier to entry: Helping breeds incumbency: the firms with scale can absorb compliance costs, pushing out smaller, more inclusion-focused challengers.
Thus, the danger is that the very frontier providers that reach the underserved might be retrenched or excluded.
Hence, policy design must thread the needle: protecting systemic stability without extinguishing inclusive innovation.
Toward a principled regulatory balance
Drawing on Lagarde’s signals, Bhatia’s pre-crisis foresight, and the inclusion imperative, here are policy principles and recommendations for Europe, with lessons for Africa and global markets:
- Function-over-form regulation
As Bhatia argued, regulation should focus on what entities do, not their legal identity. If a nonbank takes credit risk, maturity transformation, or liquidity exposure, it should face proportional oversight. - Proportionality & calibrated thresholds
Regulation should scale with risk and size. Smaller, non-systemic fintechs should face less burdensome rules than large leverage funds. This preserves room for inclusive, experimental models. - Transparency, reporting, and visibility
Mandate disclosures about leverage, funding sources, redemption pressures, and correlated exposures. Make the “shadow” less opaque. Stress testing of nonbank sectors (as EU is now planning) should become routine. - Liquidity backstops & limits
In some cases, enforce liquidity buffers or restrictions on margin calls, redemption gates, or “run risk” protection (akin to money market fund reforms). That said, implicit central bank guarantees should remain circumscribed. - Interconnectedness metrics & macroprudential overlay
Supervisors should monitor exposures between banks and nonbanks, contagion channels, and systemic feedback loops. Macroprudential tools should be extended to the broader market-based finance space. - Regulatory sandboxes and phased implementation
Permit experimental models under oversight — especially for inclusion-driven fintechs — so that regulators can learn and adapt. - Harmonization across jurisdictions
In Europe, coordinate across banking, securities, and insurance regulators to avoid arbitrage. For Africa, regional bodies (WAEMU, CEMAC, EAC) must pursue coherent cross-border frameworks to avoid fragmentation. - Capacity building & supervisory resources
Especially in emerging markets, regulators need technical capacity to assess complex instruments, stress channels, and model risk. - Guardrails, not roadblocks
Oversight should not choke innovation; rather, it should establish safe corridors for new entrants to compete on trust, not opacity.
A glance at African relevance
Though the European context is different, many of Lagarde’s concerns resonate in African financial systems:
- Rapid growth of nonbank lending: Microfinance institutions, fintech credit providers, peer-to-peer lenders, and digital credit platforms operate outside traditional banking supervision in many countries.
- Regulatory gaps: Many jurisdictions lack a unified regulatory perimeter covering nonbank players.
- Financial instability risk: Unchecked proliferation of algorithmic credit, high cycling defaults, and correlated exposure across players could threaten system stability.
- Inclusion vs risk trade-off: The firms reaching underserved segments often rely on lightweight risk models, which may accumulate hidden vulnerabilities.
- Need for cross-border cooperation: As fintechs straddle regional markets, harmonized oversight would prevent regulatory arbitrage and uneven market dynamics.
African policymakers can draw from the European moment to build anticipatory regulation—before vulnerabilities scale—and to preserve the space for socially oriented fintechs.
Conclusion
Lagarde’s call to tighten rules around non-bank financial actors is more than a regulatory pivot — it is a reminder that the boundaries of oversight must evolve to keep pace with financial innovation. Bhatia’s early warnings about function-based oversight and regulatory gaps remain eerily prescient today.
For Europe, the challenge is to level up oversight, not dilute bank standards. For Africa and emerging markets, the opportunity is to learn from this moment, building frameworks that protect stability without occluding inclusion.
The real question is not whether to regulate non-banks, but how to regulate them—in ways that preserve innovation, enable access, and guard the system’s resilience. In an era where financial inclusion, fintech experiments, and stability ambitions all compete, the art of regulation lies in designing guardrails that lift rather than restrict.
Biography
Estelle BRACK scales impact-driven fintechs, connecting capital, talent, and projects to transform the future of financial services in Africa.
Estelle holds a Ph.D. in Economics & Banking and brings 25 years of operational experience in the financial sector — especially in Payments — with a global vision bridging Europe and Africa.
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