Shadow banking grows despite stigma

Author: Lizzie Meager | Published: 20 Nov 2015
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Shadow banking has continued to proliferate despite a lack of common understanding over how best to regulate it.

Recent findings from the Financial Stability Board (FSB) have highlighted rapid growth across all sectors that fall under the shadow banking umbrella. It found the size of the market to have grown by 10.1 percent in 2014, compared with conventional banks’ 6.4 percent growth.

On the same day, it also finalised its new regulatory framework for haircuts on core securities transactions; the first of its kind to be applied to such deals specifically between non-banks. The new standard collateral figure is six percent.

“It’s telling that even the FSB isn’t close to producing real recommendations,” said Thomas Raphael QC of 20 Essex Street, who worked on the rights issue case brought against Royal Bank of Scotland in 2008. “The introduction of haircuts is presented as a big change, but it’s not actually clear yet how even that will be implemented.”

Considering the Bank of England governor Mark Carney named shadow banking in emerging markets as the single greatest danger to the global economy in late 2013, the practice is marred by contention.

"It’s telling that even the FSB isn’t close to producing real recommendations"

The general perception is that these institutions hold masses of highly leveraged debt in their portfolios, along with disproportionate levels of risk.

And as well as how best to regulate it, many in the industry remain split over what actually constitutes a shadow bank.

The debate is a divisive one, mainly because asset management firms – which make up a large proportion of all shadow banking institutions – are regulated by the Alternative Investment Fund Managers Directive (AIFMD), which came into force in 2011.

“It’s a perfectly robust framework, and a substantial piece of legislation,” said Diala Minott, a partner at Ashurst. “So it’s wrong to say European investment firms aren’t regulated.”


  • The FSB last week published a series of recent reports in which it found shadow banking activity to have grown by 10.1% over 2014;
  • This is despite repeated calls to regulate these firms more heavily;
  • It also introduced 6% haircuts for core securities transactions between non-banks.

Long way to go

This year the FSB has introduced a new method of system-wide monitoring, which it calls an activity-based economic function approach, to identify the areas within non-bank activities where risks are most likely to arise. Using this method, it found that around 30% of the overall non-bank lending market falls into this category.

These areas are identified as ‘other financial intermediaries’, and in 2015 include money market funds, finance companies, structured finance vehicles, hedge funds, broker-dealers, and investment trusts and funds.

Much of the growth over the past year came from trusts and money market funds in China. Carney highlighted Chinese debt specifically as a risk to global economic stability as recently as October this year.

Mark Carney
Mark Carney Bank of England
But although non-bank activity is thought to have been one of many catalysts for the financial crisis, from the FSB’s released materials, it doesn’t seem any closer to a solution.

“There isn’t the same level of specific, systemic risk as there is with conventional banks,” said Raphael. “Central banks aren’t going to fund shadow banks in a crisis, for example.”

And there are somewhat contradictory messages coming from regulators and other authorities across Europe.

While the UK government is encouraging asset managers to provide more funding to SMEs [small and medium enterprises], this is at odds with repeated calls to regulate the industry more rigorously.

“There’s this tension between asking people to go out and lend in large amounts and boost the economy, while simultaneously wanting to pile on harsher regulations, which will ultimately make funding harder,” said Minott.

Whatever the ultimate policy decision, the debate rages on.

“Lumping experienced, stable asset management firms in the same category as peer to peer lenders like payday loan companies is a misnomer,” said Minott. “Call it alternative lending, non-bank lending or private debt – but not shadow banking.”

See also

How shadow banking rules would hit Europe project finance

The risks of shadow banking’s growth

IMF: shadow banking’s next steps