European Central Bank ("ECB") staff outlined systemic risks of shadow banking and advocated the collection of additional balance sheet data by using an "activities-based approach." In a recent paper, ECB staff advocated implementing an "activity-based" monitoring of the following activities: (i) securitization transactions, (ii) securities financing transactions (repo and securities lending), (iii) collateral management services, and (iv) any economically equivalent functions through derivatives markets.
The Financial Stability Board ("FSB") defines shadow banking as "credit intermediation that involves entities and activities (fully or partly) outside the regular banking system." ECB staff analyzed FSB statistics that showed increases in shadow banking driven primarily by investment funds.
The paper highlighted the risks attributable to the expanded investment fund sector:
- unlike banks, investment funds do not have access to central bank liquidity;
- the shadow banking sector is highly interconnected with Euro area banks, and serves as an important source of credit for non-financial corporate banks;
- the "liquidity mismatch" within the investment fund sector is growing; and
- the use of synthetic leverage "can add to propagating distress through counterparty links and collateral values."
ECB staff noted that there were limitations in the current data, but asserted that the shadow-banking sector "has acted as a buffer for the real economy [by] providing an invaluable source of funding as bank credit contracted."
Commentary / Steven Lofchie
Global regulators impose regulations on banks that make them less competitive in the lending market (despite the lower cost of borrowing). The report recognizes that non-banks have stepped in where the banks were disabled.
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