These heightened capital requirements for licensed banks may trigger even more regulatory arbitrage than was observed in the recent past, thereby inducing a large migration of banking activities towards the shadow banking system. The higher solvency of the licensed banking system may then be more than offset by such growth in shadow banking, ultimately increasing the aggregate exposure of the money-like liabilities issued by both the formal and shadow banking sectors to shocks on loans.

It has generally been acknowledged that shadow banking was the “epicenter for the global financial crisis. High leverage made the shadow banking system fragile, and an initial run on shadow institutions was then transmitted throughout an interconnected global banking system. Despite this bit of now seemingly conventional wisdom, the primary response from regulators to the financial crisis has been to increase the capital requirements for chartered banks.  A new paper by Guillaume Plantin of the Toulouse School of Economics and CEPR posits that this seemingly misplaced focus not only leaves many aspects of shadow banking unaddressed by regulators, but also may foster more regulatory arbitrage and drive more banking activities to the shadow banking system.

Following its September meeting in Cairns, the Financial Stability Board (FSB) has published a press release highlighting some of the vulnerability the FSB still sees as threatening the global financial system.  The release also lays out some work plans for some of the FSB’s ongoing core financial reform efforts, including the area of shadow banking.  

On January 29, 2014, the European Commission issued its long awaited proposal for the establishment of a central database for Secured Financing Transactions. This release is a part of a larger regulatory effort aimed at increasing the transparency of certain transactions in the shadow banking sector and to prevent regulatory arbitrage. The proposal aims to increase transparency in secured financing transactions, a term which is defined broadly to include repo, reverse repo, tri-party repo, securities lending transactions as well as total return swaps, collateral swaps and buy-sell transactions.