But rules and regulations are effective only if aimed at the right targets. The question is whether traditional banks should be so much in the regulatory spotlight. Or have the regulators missed some risks lurking in the shadows?
One of those potential risks is aptly known as “shadow banking”, a term used to cover types of non-bank entities and certain types of activities by non-banks and banks. These are those largely unregulated pools of liquidity and capital that have become increasingly important as our economies come out of recession.
What is already clear is that shadow banking is here to stay. It can be an important part of a vibrant and safe financial system, if properly understood and regulated.
Let’s be clear: unregulated non-bank entities that conduct banking activities can pose risks and should be regulated. This need not destroy that sector but should facilitate growth and stability. The regulation could mimic that already in place for building societies and credit unions – some prudent capital requirements, liquidity, competence and reporting requirements.
In contrast, non-deposit fundraising by banks that does not properly fall within the notion of shadow banking should not be regulated further. Debt markets funding by banks is already highly regulated by the Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC) and their equivalents offshore. The resurgent debt capital markets are a good example of post-GFC growth despite additional regulation. But enough is enough.
If we take types of non-bank entities first, in Australia the most important of these have been building societies and finance companies that fund home loans and commercial lending.
To a lesser extent, investment and hedge funds have expanded the range of equity investors. Offshore, that list would expand to include commercial trusts, mutual funds, sovereign wealth funds, private equity and money market funds.
The activities that some have suggested can fall within shadow banking include securitisation, securities lending, and repurchase arrangements and structured credit transactions (often involving complex derivatives). Both regulated banks and non-banks entities are involved in those activities. However, much of that activity by banks (not non-banks) is not shadow banking.
Financial Sector Composition