Shadow Banking

On 19 March 2012, the European Commission issued a Green Paper on shadow banking. This consultation paper extended several regulatory reform initiatives in the financial sector in order to establish rules to control the ”non-bank credit activities” which is regarded as not being adequately regulated and supervised.

According to the Financial Stability Board the size of the global shadow banking system may be estimated at around €51 trillion in 2011, up from €21 trillion in 2002. This represents a large part of the total financial system. Shadow banking is therefore of systemic importance for Europe’s financial system.

This terminology, coined by Paul McCulley of PIMCO, could be defined as any banking like activity, either maturity transformation or liquidityor credit intermediation, performed by non-bank licenced, but regulated, entities.

After tackling banking regulation, these initiatives are aimed at creating a stronger financial sector at the service of the economy: shadow banking performs important functions in the financial system but can also pose potential threats to long term stability.

In parallel to the IOSCO/FSB consultation of November 2012 (to which the ABBL responded), the European Commission will examine five key areas:

  •     Banking Regulation
  •     Asset Management Regulation
  •     Securities lending and repurchase agreements
  •     Securitisation
  •     Other shadow banking entities

And there are five types of bodies that appear to be concerned:

  •     Financial bodies that are active in intermediation or other credit granting but do not accept deposits and are not regulated in the same way as banks;
  •     Funds, including exchange traded funds (ETFs), that invest in credit products;
  •     Monetary funds or certain equivalent products;
  •     Insurers providing credit guarantees;
  •     Specific investment or financing vehicles.

It is expected that the European Commission will adopt on 18 September 2013 a communication on shadow banking, which has already been postponed several times.

The ABBL believes that the approach to shadow banking raises questions regarding the scope and underlying reasons to regulate.

It covers both the depth as well as the types of measures envisaged. Some increased transparency may bring benefits, but may also be a burden on the activities up to the point of rendering them impossible. This may be especially damaging for Money Market Funds (MMF), or in the securitisation/REPO/securities lending areas.

Moreover, some of these areas are already subject to direct specific regulation, such as the fund sector, for example, or indirect regulation as in the case of REPOs where at the very least one side of the transaction, namely the bank, is prudentially regulated.

Shadow banking has been developed to support the economy and banks in their interaction with the other economic agents. Any new rules should thus be carefully analysed before they render some activities impossible. Indeed, under some scenarios new rules make some central bank supporting activities impossible to the detriment of the economy (ECB LTRO).