Monday, November 19, 2012

Europe Plans on Regulating "Shadow Banking"

Europe is preparing to regulate so-called "shadow banking." (See this article from Der Spiegel, and this article from CNBC). The articles don't do a very good job of defining what they mean by "shadow banking." Wikipedia provides a probably oversimplified explanation:
The shadow banking system is the collection of non-bank financial intermediaries that provide services similar to traditional commercial banks. It includes entities such as hedge funds, money market funds and structured investment vehicles (SIV). Investment banks may conduct much of their business in the shadow banking system (SBS), but most are not SBS institutions themselves.

. . . Shadow institutions typically do not have banking licenses and don't take deposits like a depository bank and therefore are not subject to the same regulations. Complex legal entities comprising the system include hedge funds, structured investment vehicles (SIV), special purpose entity conduits (SPE), money market funds, repurchase agreement (repo) markets and other non-bank financial institutions.
Shadow banking institutions are typically intermediaries between investors and borrowers. For example, an institutional investor like a pension fund may be willing to lend money, while a corporation may be searching for funds to borrow. The shadow banking institution will channel funds from the investor(s) to the corporation, profiting either from fees or from the difference in interest rates between what it pays the investor(s) and what it receives from the borrower.
The Der Spiegel article notes, however, that:
At the moment, very little is known about many of the shadow companies. Precisely because they remained largely unregulated for so long, there is no government agency that could order them to provide information. "It's a classic chicken-and-egg problem," says Andresen. Without regulation there can be no data, and without data there can be no regulation.

Even the question of who should handle data collection in the future has triggered a dispute between politicians and regulators. It isn't easy to bring together opinions from the 20 countries whose governments meet regularly at the G-20 summits of leading industrial and emerging economies. To get the mammoth problem under control, FSB staff members have compiled a "world map of shadow banks," as Andresen calls the puzzle-like project.

Fifty different types of companies have been identified, and the FSB now intends to focus on the roughly 10 most common types. Regulators suspect that these companies alone have assets totalling $20 trillion.

But the more detailed the research is, the more difficult it gets. For instance, Germany's financial regulator BaFin called for the broad documentation and regulation of hedge funds, only to be blocked by Great Britain and the United States -- not surprisingly, given that many of these funds are headquartered in London and New York. Now only hedge funds that engage in real credit transactions will be subject to greater scrutiny in the future, a group that makes up less than a third of the industry.
In other words, the financial transactions are disparate enough that it is difficult to categorize and define that fits into the "shadow banking." Which begs the question of whether they could effectively regulate the industries.

However, an even more basic question is why they need to be regulated. Is this simply an issue of the Eurocrats offended that some businesses have escaped their regulatory grasp? The CNBC article states:
A report by the Financial Stability Board (FSB) on Sunday appeared to confirm fears among policymakers that shadow banking is set to thrive, beyond the reach of a regulatory net tightening around traditional banks and banking activities.
The FSB, a task force from the world's top 20 economies, also called for greater regulatory control of shadow banking.
"The FSB is of the view that the authorities' approach to shadow banking has to be a targeted one," the group wrote in a report, noting the current lax regulation of the sector.
"The objective is to ensure that shadow banking is subject to appropriate oversight and regulation to address bank-like risks to financial stability," it said.
The Der Spiegel article also mentions:
After the financial crisis of 2008, German Chancellor Angela Merkel, of the center-right Christian Democratic Union (CDU), said that there could be no "blind spots" on the map of financial market regulation. But while more and more laws were passed to control banks, regulation of the shadow banks is only just beginning.

The man who is supposed to bring about the necessary change works in an office tower far away from major financial centers. When Svein Andresen broods over how he can best go about taming the wild masters of money, he sees the Black Forest through his office window. The level-headed Norwegian is the secretary general of the Financial Stability Board (FSB), which is housed at the Bank for International Settlements in Basel, Switzerland, the umbrella organization of the world's central banks.

The FSB is intended to avert a repeat of disasters like the 2008 crisis. "For years, governments and regulatory agencies paid too little attention to financial institutions outside the world of banking," says Andresen. Now he wants to bring order to the chaotic world of shadow banks. But it's a slow process.
The "sin" of the financial crises was allowing commercial banks to act like investment banks. This seems to be a push to regulate simply for the sake of regulation.

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