Shadow banking, i.e., credit intermediation outside the regular banking system, may represent the greatest challenge facing financial policy makers today. Since the G20 Summits in Seoul in 2010 and Cannes in 2011, regulators have struggled to envision the changes needed to reign in shadow banking practices. At an
April 27 conference in Brussels, which was dedicated solely to shadow banking, the European Commission released a
Consultation Paper with three questions intended to guide future regulation.
According to the Financial Stability Board, the shadow banking system amounted to 46 trillion euro in 2010, representing between 25 and 30% of the total financial system at the time. Given the size and economic importance of shadow banking activities, regulators are understandably treading cautiously in their reform proposals. Rather than diving headlong into the regulatory fray, the European Commission is seeking answers to three key questions:
- Do the new rules that we are putting in place in the 'traditional' financial sector entice certain banking activities to move to the non-regulated sector?
- Do we have the right rules to avoid the possibility that the shadow banking system becomes in practice a synonym for risk areas? Do the supervisors have the means to identify and evaluate the risks?
- What role does shadow banking play in the financing of the real economy? Could it play this role more efficiently?
The goal of the Commission's Consultation paper is to lay a foundation for answering those key questions. At a basic level, the paper seeks to define what falls within the scope of "shadow banking," including:
- Money Market Funds (MMFs) and other types of investment funds or products with deposit-like characteristics
- Investment funds that provide credit or are leveraged, including Exchange Traded Funds (ETFs) and hedge funds
- Finance companies and securities entities providing credit or credit guarantees or performing liquidity and/or maturity transformation without being regulated like a bank
- Insurance and reinsurance undertakings which issue or guarantee credit products, and
- Securitization and securities lending and repurchase agreement (repo) transactions.
As well as clarifying the playing field of "shadow banking," the Consultation Paper has three very practical objectives:
- Review the numerous measures already adopted in relation to certain activities and players in the shadow banking system, like Alternative Investment Fund Managers, UCITS and the strengthening of capital requirements for banks and insurance companies, and fill any gaps.
- Allow all the stakeholders, particularly all the financial intermediaries who will be affected, to have the opportunity to provide their input.
- To assess the risks presented by "shadow banking" and list the issues that must be addressed.
Using input it receives from shadow banking players, the Commission plans to publish further guidance on the future of reforms. As a next step, the Commission will seek input and perform further investigation on banking, asset management, securities lending and repurchase agreements, securitisation, and other shadow banking entities.
Comments on the Consultation Paper are due by June 1, 2012.