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Roadmap for Tackling Risks in Shadow Banking

Compliments of EACCNY Member Houthoff Buruma

Shadow banking is a hot topic in the financial and regulatory world. Shadow banking was defined by the Financial Stability Board as the system of credit intermediation that involves entities and activities outside the regular banking system. Although shadow banks conduct activities similar to those of banks, unlike banks, they are currently not regulated.

The relevance of shadow banking is partly caused by its size. The FSB has roughly estimated the size of the global shadow banking system at around € 51 trillion in 2011. This represents 20 – 30% of the total financial system and half the size of bank assets.

Shadow banking activities are generally seen as a useful part of the financial system, since they create alternative investment possibilities for investors. However, in the last few years shadow banking has attracted the attention of regulators due to the risks involved with it. There are concerns that more business entities may move into the shadow banking system as regulators seek to strengthen the financial system by making bank rules stricter. In addition to risks associated with circumventing existing rules, shadow banking needs to be monitored because of its size, its close links to the regulated financial sector and the systemic risk that this poses. The links to the regulated financial sector are partly due to the fact that many shadow banking entities are sponsored by banks.

Different measures have already been taken to tackle certain risks, such as harmonised rules applying to hedge fund activities (AIFMD). The EU Commission has recently described the additional measures it is looking at in its ”Roadmap” of 4 September 2013 (Commission’s roadmap for tackling the risks inherent in shadow banking – 4 September 2013). Part of this road map are proposed new rules for money market funds (MMF’s) (Proposal for a regulation of the European Parliament and of the Council on Money Market Funds). These rules include minimum capital requirements and requirements in relation to the assets–classes MMF’s can invest in. Furthermore, the FSB is currently taking aim at securities lending and repos and has published policy recommendations in this respect in August (Strengthening Oversight and Regulation of Shadow Banking – 29 August 2013).

We expect shadow banking to remain a special area of attention for regulators in the coming years and foresee that this attention may lead to new rules with a large impact on the parties active in this sector.

QUESTIONS?

Jessica Terpstra, Partner
+442074225042 | j.terpstra@houthoff.com