Towards Better Regulation of the Shadow Banking System
SPEECH/12/310
Michel Barnier
European Commissioner for Internal Market and Services
Towards better regulation of the shadow banking system
Conference on the shadow banking system
Brussels , 27 April 2012
Ladies and Gentlemen,
Good morning to each and every one of you, and thank you for joining us at this important conference on the shadow banking system.
I should like to extend special thanks to all the members of the panel for their participation today, and to the Directorate-General for Internal Market and Services for taking care of the organisation.
The fact that so many of you have chosen to join us today shows how much of a challenge this phenomenon of "shadow banking" presents:
First of all by its size:
- In 2010, the Financial Stability Board estimated that the shadow banking system amounted to 46 trillion euro. This represented between 25 and 30% of the total financial system
- by the practices on which it is based: according to the latest IMF estimates, the same security is on average lent 2.4 times.
It is a challenge for Europe but also for the whole of the global economy.
Regulation of the shadow banking system has been on the G20 agenda since the Seoul summit in 2010.
I consider it to be an integral part of the reinforcement of our financial regulation, since we must ensure that all of the new rules we put in place do not have the effect of pushing certain banking activities towards the non-regulated sector.
What lessons have we drawn from the crisis if we allow risky activities to prosper alongside better regulated and more solid ones? We are simply moving the risks off the radar of the supervisors.
For all that, this is not about penalising players in the shadow banking system who play an important role in financing the real economy.
I think we have to ask three questions – and I am counting on your work here today to help us answer them:
- do the new rules that we are putting in place in the 'traditional' financial sector entice certain banking activities to move to the non-regulated sector?
- do we have the right rules to avoid that the shadow banking system becomes in practice a synonym for risk areas? Do the supervisors have the means to identify and evaluate the risks?
- finally, what role does shadow banking play in the financing of the real economy? Could it play this role more efficiently?
It is to find replies to these questions - which are being asked not only in Europe but for which Europe can provide the replies - that I wanted to make shadow banking one of our priorities for 2012, alongside other key topics such as the European framework for the prevention and resolution of banking crises, a discussion of the structural measures in the banking sector and measures to protect investors and users of financial services.
Ladies and Gentlemen,
I want to keep this speech brief and to leave as much time as possible for this morning’s panel discussions.
But I would nonetheless like to say a few words about the goals of the ongoing consultation, our aims as far as the regulation of "shadow banking" is concerned, and where our discussion will go from here.
I – First point: What is the goal of the Green Paper we published a month ago?
The first aim of this consultation document – a clear definition of shadow banking – is not the easiest to reach.
If we wish to clearly identify all of the players and contribute to the work going on at international level – particularly within the framework of the FSB – we will have to reach an agreement on what this concept actually means.
This task is made all the more difficult by the fact that "shadow banking" is a "complex ecosystem" with close ties to the traditional banking system. One of the challenges we face is the pro-cyclic nature of the system: while it often provides liquidity during prosperous times, it can, conversely, consume liquidity during moments of crisis.
Of course, it is far too early to reach any specific conclusions. However, based on the work carried out by the FSB, we have so far identified two main activities worthy of our attention: firstly, securitisation, and secondly, securities lending or borrowing with repurchasing ("repo").
Furthermore, there are five types of bodies that appear to be concerned by the shadow banking system:
- financial bodies that are active in intermediation or other credit granting but do not accept deposits and are not regulated in the same way as banks;
-funds, including exchange traded funds (ETFs), that invest in credit products;
-monetary funds or certain equivalent products;
-insurers providing credit guarantees;
-and lastly, specific investment or financing vehicles.
As well as clarifying the field of "shadow banking", our Green Paper has three other objectives:
1. Our first aim is to review the numerous measures we have already adopted in relation to certain activities and players in the shadow banking system. I am thinking in particular of our texts on Alternative Investment Fund Managers, UCITS and the strengthening of capital requirements for banks and insurance companies, which all include measures on shadow banking. We are not starting at zero, but we have to fill the gaps.
2. The consultation should then enable us to consult all the stakeholders so that everyone – particularly all the financial intermediaries who feel concerned by this matter – can have the opportunity to put across their point of view.
3. Lastly, and more practically, we aim to assess the risks presented by "shadow banking" and list the issues we need to address.
Ladies and Gentlemen,
II – Second point: What do we hope to achieve by regulating the system?
It is, of course, far too early to go into detail and make specific proposals for the various activities and players involved in "shadow banking": that is, in fact, the aim of the consultation exercise and of today’s session.
However, I would like to establish four general principles from the outset:
1. First of all, we aim to ensure that regulators and supervisory authorities can have a complete overview. In other words, they need to have the means and powers to familiarise themselves with and master the leverage exerted by all the financial intermediaries in the shadow banking system.
Here I am thinking in particular of practices such as securities lending, rehypothecation and repurchasing, which can lead to excessive risk-taking, sheep-like behaviour ("runs") and excessive volatility in liquidity provision. These practices, left unchecked, played a decisive role in the difficulties faced by AIG, Bear Stearns and Lehman Brothers.
We must be in a position to identify who owns what along the financing chains linked to these practices. And we must improve the transparency, supervision and security of these practices for all players on the market, wherever they may be situated along the securities lending chain. Lastly, we must ensure that the supervisory authorities are properly equipped to control the total leverage exerted by these practices. These issues could be included in our discussion of the standardisation of securities law in Europe.
2. Second general principle: we do not wish to repeat the mistakes made with the special securitisation vehicles, which were left to develop by the supervisory authorities and which served no purpose other than regulatory arbitrage. Our aim this time around is to prevent rather than cure.
3. Thirdly, we will be very careful not to call into question the alternative financing chains, which complement bank lending and are of direct benefit to the real economy. I do not think that financial intermediation should be left entirely and solely in the hands of the banks. And I am aware of the role that alternative sources of financing have to play in these difficult times for the European economy, where the banks have to adhere to more stringent prudential ratios. Alternative financing is therefore necessary, but it is important that it is carried out in a solid and transparent framework.
Monetary funds can play a useful role here, since they can provide substantial financing in the short term. However, the financial crisis showed that such funds, particularly those offering a stable Net Asset Value to investors, could be vulnerable to mass buy-backs.
We are therefore coordinating with the work currently underway within the FSB and IOSCO to look into ways of improving the regulatory framework in order to minimise the structural weaknesses of these funds. This is one of the main priorities of our Green Paper.
4. Lastly, we must, of course, ensure consistent regulation across the various financial sectors. In particular, I believe that the minimum capital to be tied up for a single operation must be comparable across all sectors to avoid encouraging any form of supervisory arbitrage.
Ladies and Gentlemen,
III – Where do our discussions go from here?
As you can see, we have a complex task before us, and we must not make any mistakes. We are already very active at international level, and the Green Paper and the responses already received will be very useful as we prepare for the next stages, specifically the G20 meeting in Los Cabos in June.
The FSB and the international standard-setting organisations will then publish their conclusions and recommendations during the second half of 2012.
The expert group chaired by the governor of Finland’s central bank, Erkki LIIKANEN, which I have asked to make proposals on the structure of the banking sector, will issue its report in October. Our discussions of shadow banking will naturally have to take into account any structural measures which that report may propose.
We will use all these elements as a starting point for targeted sectoral consultation exercises, which will most probably be followed by proposals for regulations. We should aim to have these measures take effect as early as possible, chiefly to avoid too great a time-lag in relation to the Basel III rules and the European Market Infrastructure Regulation (EMIR).
Ladies and Gentlemen,
As you can see, we are determined to see the task of regulating the shadow banking system through to a successful conclusion.
However, we must still proceed with caution. I am aware of the complexity of the issue, and especially of the need to ensure consistent regulation for all players while not calling into question the alternative sources of financing that can be so beneficial to the real economy.
It is for this reason that we are working in such close cooperation with our international partners, specifically within the G20 and the FSB.
It is also for this reason that I attach such great importance to consulting all the interested parties.
I wish you a successful and productive day, and I would call on those of you who have not yet sent us their reaction to the Green Paper to do so before the first of June.
Thank you for your attention.
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