While banks are dumping risky assets as regulation bites, asset managers are plugging the funding gap and using their growing clout in ways that could harm markets, the Bank for International Settlements says.
Nearly six years after the financial crisis forced taxpayers to bail out lenders, the global forum for central banks said in its annual report on Sunday that the financial system is at a crossroads.
Banks are reconfiguring their business by ditching risky assets to limit how much extra capital they must hold under tougher new rules aimed at avoiding bailouts in future crises.
"In the advanced economies most affected by the crisis, bank credit to corporates has ceded ground to market-based financing," the BIS report said.
The asset management sector's growth to more than $60 trillion under management has coincided with an increase in the market share of the biggest players, with the top 20 managers representing over a quarter of the sector.
The global Financial Stability Board (FSB), based in the same building as the BIS in Basel, Switzerland, is facing opposition from big asset managers to its plans to impose tougher supervision on them.
The BIS acknowledges benefits in market-based finance.
The European Union is encouraging funds to put money into infrastructure as about 70 percent of funding for the economy in the 28-country bloc comes from banks.
But the BIS cautioned that asset managers can hurt market dynamics and funding costs.
"Portfolio managers are evaluated on the basis of short-term performance, and revenues are linked to fluctuations in customer fund flows," the report said.
"Single firms in charge of large asset portfolios may at times exert disproportionate influence on market dynamics. Another concern arising from concentration is that operational or legal problems at a large asset management company may have disproportionate systemic effects," the report said.
The BIS said there are still doubts over the core capital ratios - the main measure of a bank's health - being published by lenders. There are variations in how banks calculate ratios by assigning risk weightings to their assets.
"The combined effect of these varying practices suggest that there is scope for inconsistency in risk assessments and hence in regulatory ratios," the report said.
A key driver of the variations is in the way banks set aside capital, if at all, to cover possible default on the sovereign debt they hold.
But the report stops short of backing some policymakers who want an end to the "zero" risk weighting assigned to more than half of the sovereign debt held by banks. The need to bail out several EU countries showed that sovereign debt can lose its value sharply.
The BIS also stops short of backing the calls from hawkish regulators in Britain and the United States who want radical changes to the models big banks use to assign risk weightings.
The report said models used by banks permit a "natural and welcome diversity of risk assessments among banks".
More objective measurement of underlying risks was needed, along with better supervisory safeguards on the use of models, the BIS report said.
Introducing a single regulatory model, such as a unique set of risk weights that all banks must use, could encourage risk concentration, the report added.