* ECB’s Constancio warns of shadow banking dangers
* EU’s Barnier promises to give regulators overview
* Unchartered 46 trillion euro sector exacerbated crisis
By John O’Donnell
BRUSSELS, April 27 (Reuters) – The European Commission
pledged to tighten control of so-called shadow banking on
Friday, answering c e ntral bank calls for stricter regulation of
the sprawling 46 trillion euro sector which has been blamed for
aggravating the financial crisis.
Policymakers fear that as the regulatory net closes on
banks, shadow banking will thrive, with activities traditionally
carried out by banks escaping the watch of regulators.
Officials see tighter control of the sector in Europe as
important in preventing a repeat of the financial crisis that
toppled banks over the past five years and rocked the euro zone.
“We are interested in the possible dangers for financial
stability arising from shadow banking activities,” Vitor
Constancio, the European Central Bank’s vice president, told
officials, lobbyists and experts.
“We are concerned about the implications of this activity
for global liquidity,” he said, calling for the creation of a
central database to record information about the repo market,
where banks lend on the back of securities.
Michel Barnier, the EU official responsible for financial
regulation and who is examining rule changes for shadow banking,
said he aimed to give regulators “a complete overview”.
But first officials need to have a better understanding one
of the most complex and opaque parts of finance.
“What exactly is shadow banking?” Barnier asked. “How can we
clarify it? We have to understand before we act…shadow banking
is an extremely complex ecosystem.”
Hedge funds and private equity are often cited as examples
of shadow banking. But the term can also take in investment
funds, insurers and even cash-rich firms that lend government
bonds to banks, and which in turn use them as security when
taking credit from the European Central Bank.
Even the man credited with coining the term, former PIMCO
executive Paul McCulley, gave a catch-all definition.
McCulley said he understood shadow banking to mean “the
whole alphabet soup of levered up non-bank investment conduits,
vehicles and structures”, such as the special investment
vehicles that many blamed for the financial crisis.
Some were keen to move the debate forward.
Paul Tucker, deputy governor of the Bank of England, urged
prompt regulatory action to tackle the sector and avoiding
getting bogged down in definitions.
“This should not be about eliminating shadow banking,” he
told the meeting. “We need to be able to monitor the system and
respond flexibly.”
SHADES IN THE SHADOWS
Tucker, seen as one of the favourites to become the next
head of the Bank of England, underscored the shadow system’s
close relationship with traditional banking, recommending that
banks should reflect the risk of any such activities they
undertake with extra capital safeguards.
“There are degrees of shadow banking. Many examples of
shadow banking… are part of banks,” he said. “They should be
consolidated onto the balance sheets of banks.”
His comments were echoed by Manmohan Singh, an economist
with the International Monetary Fund. “Even within a bank, you
have shadows,” he said.
The shadow banking sector has more than doubled in size over
the past decade to the equivalent of half of all bank assets in
2010.
Forms of shadow banking can include securitisation, which
can transform bank loans into a tradeable instrument that can
then be used to refinance credit, making it easier to lend.
In the run-up to the crisis, however, banks such as
Germany’s IKB stored billions of euros of such instruments in
off-balance sheet vehicles, which later unravelled.
Another example is a repurchasing agreement, or repo, where
a player such as a hedge fund could sell government bonds it
owns to a bank, agreeing to repurchase them later.
The bank may then lend those bonds onto another hedge fund,
taking a position on the government debt.
Such agreements are used by banks to lend and borrow. A risk
could arise if one of the parties in the chain collapses.
The European Commission will propose EU-wide rules for
shadow banking next year after a global regulatory body, the
Financial Stability Board (FSB) completes work on policy
recommendations for world leaders by November.
The FSB, of which Tucker is a member, said in an interim
report on securities lending and repos there was a lack of
transparency, potential risks from fire sales of collateral
assets, and insufficient rigour in tracking the value of
securities.
“The biggest single difficulty is what they mean by the
term, which is rather emotional than precise,” said Graham
Bishop, who advises banks on European regulatory policy.
“German covered bonds are an example of good securitisation.
They should not be lumped in with the broad definition of shadow
banking.”
