Ireland is world’s fourth-largest shadow banking hub

Ireland is home to the world's fourth-largest "shadow banking" industry, with $2.2 trillion of nonbanking financial assets based in funds, special-purpose vehicles and other little-understood entities in Dublin's IFSC, according to a report published on Tuesday.

The figure equates to almost eight times the size of the Irish economy, as measured by gross domestic product.

The US has the world’s largest shadow-banking sector, with $13.8 trillion of assets as of 2015, according to the latest annual review of the sector by the Basel-based Financial Stability Board (FSB) as it searches for potential risks in the increasingly complex world of international finance.

The Cayman Islands, which has taken part in the FSB study for first time, is the second-largest, at $4.3 trillion, followed by Japan, at $3.2 trillion.

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The G20 major industrialised and emerging economies gave the FSB the job in 2010 of keeping track of the expanding world of financial activities that take place outside of mainstream banks, given the role that the sector played in the 2008 global financial crisis. The key concern is that, as central banks have clamped down on excessive risk-taking in the banking sector in the wake of the 2008 financial crisis, lenders might extend their use of shadow banking to escape the claws of regulators.

"Market-based finance provides important diversification of the founding resources which support the real economy," said Mark Carney, governor of the Bank of England and chairman of the FSB on the release of the latest report.

“The enhanced and co-ordinated system-wide monitoring by authorities continues to improve our understanding of nonbank financial activities and risks to the financial system. This helps to inform our judgment on appropriate policy responses as we transform shadow banking into resilient market-based finance.”

China data

The FSB said China, which ranked third with Ireland in the last report, published in late 2015, didn't file data on time to be included in its narrow definition of shadow-banking activities that pose potential risks to global finance. Luxembourg, Ireland's main rival in nonbanking financial activities in Europe, has not yet taken part in the annual survey.

Nonbank financing provides a valuable alternative to bank funding and helps support economic activity, according to the FSB, adding that it can provide a “welcome” alternative supply of credit and provides “healthy competition for banks”.

The FSB has been gradually refining its definition of what elements of shadow banking should be included in its annual survey. The latest measure, which excludes assets that are ultimately accounted for on the balance sheets of banking groups, puts the size of the global shadow-banking sector at $34 trillion in 2015, up 3.2 per cent on the previous year.

“This is the equivalent of 60 per cent of gross domestic product of these 27 jurisdictions and 13 per cent of financial assets,” the report stated.

Ireland as asset manager

Ireland's shadow-banking sector is bloated by the fact that it is a major international centre for international asset managers to base funds. Some 46 per cent of Irish nonbank financial assets are made up of investment funds, many of which are administered in Dublin and are listed on the Irish Stock Exchange. A further 12 per cent are made up of money-market funds. Both these areas are heavily regulated.

However, almost a fifth of the country’s shadow-banking assets are made up of so-called special-purpose vehicles and financial-vehicle corporations. These were facilitated by laws enacted in 1997 that made it very tax-efficient to set up “securitisation” vehicles used by banks, private-equity firms and companies to raise debt finance that are secured against ringfenced assets.

However, the FSB report highlighted that a further €471 billion of "other" shadow-banking assets are based in Ireland that are not the subject of regulator reporting requirements. It said the Central Bank of Ireland faces challenges in capturing data on these "other" entities, as it is difficult to define what these involved in.

However, a separate report, published by the Central Bank last year, stated that the remainder is likely to mostly consist of treasury operations of multinationals alongside holding or financial leasing companies.

The FSB said the Central Bank is working with the Central Statistics Office as it seeks to build up a register of all financial entities based in the State, similar to an approach taken in the UK.