Shadow-banking: illuminating darkness

Hoping everything will be fine is not a good strategy when it comes to financial regulation

 

Financial regulation is a complex business but one lesson of the economic crash was the huge cost if it is not done properly. Oversight internationally and in Ireland has increased in the years since. Banks complain this can be irksome but it is the inevitable consequence of events that rocked the economy.

However as well as traditional banking and financial sectors, there is a wider agenda. So-called shadow banking – covering all kinds of non-banking financial activity – is now an increasingly important part of the picture. Including everything from mobile payment systems,to crowd-funding websites to a variety of more complex funds, non-bank finance can bring significant efficiencies and value to the financial system. But it can also lead to risk. And the sector is set to grow.

The Financial Stability Board (FSB), which was set up in the wake of the crisis as part of a global effort to prevent its repeat, began to publish an annual report on shadow banking back in 2011. Ireland – one of the biggest shadow banking hubs – only participated for the first time in the 2015 report. Some big centres, such as Luxembourg, do not take part which is not ideal given the need for international coordination of any meaningful regulation of what is essentially a global business.

About two-thirds of Ireland’s $3.9 trillion non-bank financial assets are in the heavily regulated areas of investment funds and money market funds. There is good reason for them to be subject to close scrutiny as they manage investors’ money. Another third of the Irish shadow banking universe is subject to little or no regulation – including a range of special purpose vehicles – though these at least must now file returns.

The FSB annual report puts some pressure on countries to get a handle on what’s happening on their own patch so that regulators internationally can have sensible conversations about potential risks, how they can be mitigated and what regulation or supervision is needed. If the financial crisis taught us anything, it is that crossing our fingers and hoping everything will be fine is not a good strategy when it comes to financial regulation.

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