Are the Days of Shadow Banking Over?

The European Union wants to shed regulatory light on the shadow banking industry as it tries to safeguard from future financial crises. Its executive body, the European Commission, started public consultation on Monday in an attempt to write new rules for the hitherto largely unregulated industry worth 46 trillion euro ($61 trillion). The so-called shadow banking sector had been blamed as one of the triggers for the financial crisis that hit Europe five years ago. The industry has more than doubled in size over the past decade.

“What we do not want is for financial activities and entities to circumvent existing and foreseen rules, allowing new sources of risk to accumulate in the financial sector,” said Michel Barnier, the EU Internal Market and Services Commissioner. “That is why we need to better understand what shadow banking actually is and does, and what regulation and supervision may be appropriate.”

Shadow banking operations mirror the standard banking model, but have until now differed in one important aspect: government regulation. Hedge funds, private equity funds, and money-market funds are often considered to come under the purview of shadow banking, as do the activities of firms of lending government bonds to banks.

Suggested regulations include reviewing the quality of collateral and liquidity behind securities lending and derivatives transactions between exchange-traded fund providers and their counter-parties, according to the Wall Street Journal.

The EU is not the only governing body concerned about shadow banking operations. U.S. Treasury Secretary Timothy Geithner earlier offered a warning as well. “A large shadow banking system had developed without meaningful regulation, using trillions of dollars in short-term debt to fund inherently risky financial activity,” Geithner told WSJ.

The EU will hold a conference in Brussels in April to discuss the regulations. The European Commission’s suggestions are voted on by the bloc’s 27 member states and the European Parliament before they become law.

To contact the reporter on this story: Aabha Rathee at staff.writers@wallstcheatsheet.com

To contact the editor responsible for this story: Damien Hoffman at editors@wallstcheatsheet.com