Wednesday, February 8, 2012

Watchdogs to drag shadow banks into the light

A Reuters' article discusses how global financial regulators are turning their attention towards the "shadow banking" sector of the financial system in an effort to make the financial system safer.

Hopefully, the regulators will focus on the word "shadow" and bring ultra transparency to every opaque corner of this sector (for example, structured finance securities).

[Large] swathes of the financial system remain outside the remit of the regulators, even though they provide essential funding to banks, and were at the heart of the global financial crisis. 
This sector, known as "shadow banking" -- much to the chagrin of the people operating in it -- is huge. The size of the sector was some $60 trillion in 2010, making it as big as roughly half the global banking industry.... 
A run on its funds is as much a real risk for a shadow bank as it is for a normal bank, regulators say, and could have devastating consequences for the global financial system because the two sectors are so closely linked.
Paul McCulley, the former PIMCO portfolio manager credited with coining the expression "shadow banking", warned as early as 2009 that the system "drove one of the biggest lending booms in history, and collapsed into one of the most crushing financial crisis we've ever seen". 
Governments stood behind their banks when the interbank lending market dried up at the onset of the crisis, bailing them out with billions of dollars to protect depositors. But shadow banks would have no such fall-back option.
Another risk identified by the Financial Stability Board (FSB)- the powerful body mandated by the G20 group of the world's richest economies to draw up new rules for shadow banking - is that they could be used to avoid financial regulation and attract risky activities that are banned elsewhere. 
"What we're doing now is looking at the types of data that the FSB will be gathering. The scope is pretty broad but it's important to get the facts on table and consider what activities could pose a risk," said Rick Watson at the Association for Financial Markets in Europe (AFME), a group that lobbies on behalf of securities firms and investment banks. 
The FSB has signalled a two-pronged approach to regulating shadow banking, with tough rules such as possible capital charges and limits on the size and nature of a mainstream bank's exposure to shadow banks. 
Other shadow banking activities which are seen as less systemically risky could face greater transparency requirements....
Much of the debate centers around collateral - securities such as bonds or shares that guarantee a loan much in the same way as a property in a mortgage - which has become scarce after the crisis, making it harder for banks to lend. 
The unsecured interbank lending market has almost completely dried up because banks have stopped lending to each other, so banks need more collateral to continue lending to clients. Much of this originates in shadow banks. 
Europe's banks for instance, are paying insurers and pension funds to take bonds that are hard to sell in exchange for better quality ones, in a desperate bid to secure much-needed cash from the European Central Bank (ECB). 
And blue-chip companies like Johnson & Johnson, Pfizer and Peugeot are among firms providing cash to banks, in a reversal of the established roles of clients and lenders. 
These deals between companies and banks take place in the so-called repo market, another large part of shadow banking, used to raise short-term funding against collateral....

The repo market, which in Europe alone is roughly 6 trillion euros in size, is another explicit target for the FSB, which has suggested these markets need the help of clearing and settlement houses to reduce risk. 
People working in the repo industry say the instruments themselves are safe and regulators should instead focus on the way banks use them. 

No comments: