Published on EurActiv (http://www.euractiv.com)
Source URL: http://www.euractiv.com/euro-finance/commission-tries-shed-light-shadow-banking-news-511585
Commission tries to shed light on 'shadow banking'
Published: 20 March 2012
The European Commission is set to tackle the “shadow banking” market, attempting to bring the growing sector within the regulatory fold amid fears that it is growing too large and threatens Europe's financial stability.
Hedge funds and private equity are often cited as examples of shadow banking, but the term can also take in investment funds and even cash-rich firms that lend government bonds to banks, and which in turn use them as security when taking credit from the European Central Bank.
The sector, which operates on the fringes of mainstream banking, has more than doubled to €46 trillion since 2002, when it accounted for €21 trillion of the global economy.
Political leaders have been alerted to the difficulties presented by shadow banking. In response to invitations by the G20 in Seoul in 2010 and in Cannes in 2011, the Financial Stability Board (FSB) – a G20 task force – is in the process of developing recommendations on the oversight and regulation of these entities and activities. The Commission’s green paper is designed as a parallel action to complement and track the ongoing FSB work.
Background
Hedge funds and private equity are often cited as examples of shadow banking, but the term can also take in investment funds and even cash-rich firms that lend government bonds to banks, and which in turn use them as security when taking credit from the European Central Bank.
The sector, which operates on the fringes of mainstream banking, has more than doubled to €46 trillion since 2002, when it accounted for €21 trillion of the global economy.
Political leaders have been alerted to the difficulties presented by shadow banking. In response to invitations by the G20 in Seoul in 2010 and in Cannes in 2011, the Financial Stability Board (FSB) – a G20 task force – is in the process of developing recommendations on the oversight and regulation of these entities and activities. The Commission’s green paper is designed as a parallel action to complement and track the ongoing FSB work.
A public consultation launched yesterday (19 March) aims to establish a clear definition of shadow banking – broadly meaning banking occurring outside the regulated sector – before deciding how it can best be brought under control.
Shadow banking includes credit intermediary activity by insurance companies, much hedge fund activity, deals done through special purpose vehicles and ad-hoc funds, and many so-called ‘Repo’ deals, in which assets are sold with buy-back provisions.
"Many institutions such as hedge funds act similarly to banks when, for example, they buy corporate bonds or lend to companies using the funds of investors or savers," said Graham Bishop, an expert in EU regulatory policy.
"And they face similar risks, often borrowing on a short-term basis and lending over a longer term, making them vulnerable to short-term funding risks," Bishop said.
A senior European Commission official said that shadow banking could act as a useful alternative source of funding, but also gave rise to “financial stability concerns”, particularly fears of panic runs on banks or financial markets. This is because shadow banking is frequently financed by short term funding, prone to the risk of sudden withdrawals by clients.
The official said that although shadow banking is lower than the global average in Europe - it accounts for 13% and 5% of total financing in the UK and Germany respectively, but 35% in the United States - the figure is believed to be growing.
Consultation period ends in June
“What we do not want is for financial activities and entities to circumvent existing and foreseen rules, allowing new sources of risk to accumulate in the financial sector,” said Internal Market Commissioner Michel Barnier.
“That is why we need to better understand what shadow banking actually is and does, and what regulation and supervision may be appropriate.”
The consultation period will last until 1 June, with a regulatory proposal likely to emerge after the summer, although Barnier said that he was keeping an open mind on how extensive that should be.
The shadow banking proposals form part of a general package of measures to deal with the markets in the aftermath of the financial crisis, which officials said would now move into a new post-crisis phase following the abatement the Greek sovereign debt crisis.
Measures to come on getting banks out of a fix
Proposals for crisis prevention and management in banks – a key EU measure intended to ensure there is no repeat of the banking failures witnessed during the crisis – is almost complete, officials confirmed.
One consultation has already been conducted on the paper, early last year, and a further ‘mini-consultation’ exercise is about to be launched before the final publication.
This final consultation relates to controversial measures, set to be included in the final proposal, which will envisage debt 'bail-in' by creditors of stricken banks.
Under the measures, private creditors would agree to lose a fixed ‘haircut’ on their equity in failing banks. The precise calibration of these 'bail-in' haircuts has caused concerns in member states' finance ministries and central banks. Their advice is now being sought in relation to the final draft of the proposal before publication, EurActiv understands.
Shadow banking includes credit intermediary activity by insurance companies, much hedge fund activity, deals done through special purpose vehicles and ad-hoc funds, and many so-called ‘Repo’ deals, in which assets are sold with buy-back provisions.
"Many institutions such as hedge funds act similarly to banks when, for example, they buy corporate bonds or lend to companies using the funds of investors or savers," said Graham Bishop, an expert in EU regulatory policy.
"And they face similar risks, often borrowing on a short-term basis and lending over a longer term, making them vulnerable to short-term funding risks," Bishop said.
A senior European Commission official said that shadow banking could act as a useful alternative source of funding, but also gave rise to “financial stability concerns”, particularly fears of panic runs on banks or financial markets. This is because shadow banking is frequently financed by short term funding, prone to the risk of sudden withdrawals by clients.
The official said that although shadow banking is lower than the global average in Europe - it accounts for 13% and 5% of total financing in the UK and Germany respectively, but 35% in the United States - the figure is believed to be growing.
Consultation period ends in June
“What we do not want is for financial activities and entities to circumvent existing and foreseen rules, allowing new sources of risk to accumulate in the financial sector,” said Internal Market Commissioner Michel Barnier.
“That is why we need to better understand what shadow banking actually is and does, and what regulation and supervision may be appropriate.”
The consultation period will last until 1 June, with a regulatory proposal likely to emerge after the summer, although Barnier said that he was keeping an open mind on how extensive that should be.
The shadow banking proposals form part of a general package of measures to deal with the markets in the aftermath of the financial crisis, which officials said would now move into a new post-crisis phase following the abatement the Greek sovereign debt crisis.
Measures to come on getting banks out of a fix
Proposals for crisis prevention and management in banks – a key EU measure intended to ensure there is no repeat of the banking failures witnessed during the crisis – is almost complete, officials confirmed.
One consultation has already been conducted on the paper, early last year, and a further ‘mini-consultation’ exercise is about to be launched before the final publication.
This final consultation relates to controversial measures, set to be included in the final proposal, which will envisage debt 'bail-in' by creditors of stricken banks.
Under the measures, private creditors would agree to lose a fixed ‘haircut’ on their equity in failing banks. The precise calibration of these 'bail-in' haircuts has caused concerns in member states' finance ministries and central banks. Their advice is now being sought in relation to the final draft of the proposal before publication, EurActiv understands.
Next Steps
- 1 June 2012: End of the consultation period on shadow banking
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