The shadow banking industry has grown to about $67 trillion, $6 trillion bigger than previously thought, leading global regulators to seek more oversight of financial transactions that fall outside traditional oversight.
The size of the shadow banking system, which includes the activities of money market funds, monoline insurers and off- balance sheet investment vehicles, “can create systemic risks” and “amplify market reactions when market liquidity is scarce,” the Financial Stability Board said in a report, which utilized more data than last year’s probe into the sector.
“Appropriate monitoring and regulatory frameworks for the shadow banking system needs to be in place to mitigate the build-up of risks,” the FSB said in the report published on its website.
While watchdogs have reined in excessive risk-taking by banks in the wake of the collapse of Lehman Brothers Holdings Inc. in 2008, they are concerned that lenders might use shadow banking to evade the clampdown. Michel Barnier, the European Union’s financial services chief, is planning to target money market funds in a first wave of rules for shadow banks next year.
The FSB, a global financial policy group comprised of regulators and central bankers, found that shadow banking grew by $41 trillion between 2002 and 2011. The share of activity based in the U.S. has declined from 44 percent in 2005 to 35 percent in 2011, moving to the U.K. and the rest of Europe.
Bypass Lenders
Supervisors consider shadow banking activities to be those that allow banks to carry out business off balance sheets, as well as those which allow investors to bypass lenders and the functions they traditionally fulfill on the markets.
The FSB also targeted repurchase agreements and securities lending for tougher rules, recommending that regulators implement minimum standards for calculating losses on the different types of collateral used in the transactions.
Repurchase agreements are contracts where one investor agrees to sell a security and then buy it back at a future date and a fixed price. Securities lending agreements involve institutional investors such as pension funds lending financial instruments against cash collateral.
The group is also concerned that regulators are unable to monitor the scale of the trades. Supervisors should “collect more data on securities lending and repo exposures amongst large international financial institutions with high urgency,” the FSB said in the report.
More Disclosure
Large firms should disclose more information about the deals to investors, the FSB said, and may be required to publish regular statements detailing how much collateral they have and what it is used for.
A bankruptcy examiner’s report found that Lehman used so- called Repo 105 transactions to move as much as $50 billion temporarily off its balance sheet to convince investors it wasn’t carrying too much debt.
Final rules will be submitted to leaders of the Group of 20 nations at a summit in St. Petersburg, Russia, next year, the FSB said. Mark Carney, chairman of the FSB, said earlier this month that regulators are holding “intense discussions” on shadow banks.
Shadow banking. The name alone sounds ominous — like some dangerous phantom biding its time, waiting for the perfect moment to leap from its hiding place to do its deadly work.
On a financial level, that metaphor actually works pretty well.
The shadow banking system does exist in the shadows, away from the spotlight of regulation we’ve come to expect banks to operate within. And given the right conditions, it could leap unexpectedly from its dark, financial hiding place and bring the U.S. economy to its knees, just like it nearly did in 2008.
An Honor We’d Rather Not Hold
What’s bringing this issue to the forefront again is a new report by the Financial Stability Board, an international financial-standards advisory group. It cites that assets held in the global shadow banking system hit a new high last year: $67 trillion, which comes out to about half the world’s total banking assets.
In the report, the FSB formally describes the shadow banking system as “credit intermediation involving entities and activities outside the regular banking system.” Translated into English, this means the act of borrowing, lending, or otherwise shifting of money around by financial institutions that aren’t subject to regulation, like hedge funds. It can also refer to traditional banks operating in largely unregulated arenas such as credit-default swaps.
America’s portion of this $67 trillion in global assets is $23 trillion. In terms of total share, that’s a decrease from 44 percent in 2005 to 35 percent in 2011 — still enough to give the U.S. the dubious honor of having the world’s largest shadow banking system, and more than enough to put the entire U.S. economy at risk of another credit freeze.
That’s the danger here: Without the smooth flow of cash and credit, the lifeblood of any free-market system, economic life grinds to a halt.
What Refrigerators and Lehman Brothers Have in Common
If banks aren’t lending to consumers, there’s no one to buy Ford (F) cars, General Electric (GE) refrigerators, and Apple (AAPL) iPhones that keep those companies in business. And if banks aren’t lending to other businesses, when companies like Starbucks (SBUX) need to replace its aging fleet of latte machines or Southwest Airlines (LUV) its aging fleet of 737s, they won’t be able to borrow the capital to do so.
What happened in the fall of 2008 is that banks stopped lending to other banks — part of this shadow banking system. The now-failed Lehman Brothers was then very dependent on the interbank lending market (known to bankers as the “repo market”) to fund its day-to-day operations. But as fears grew that the Wall Street titan was overexposed to defaulting mortgage debt, other banks stopped lending to it. As a direct result, Lehman Brothers went bankrupt.
Once that happened, not only did the other big banks stop lending to each other out of fear they might go bankrupt if they didn’t hang on to every last drop of capital, they stopped lending to consumers and businesses, as well, beginning the economic chain reaction described above.
This is the point where the Federal Reserve and Congress stepped in to bail out the banks: not only to ensure that those that made it through the crash had enough capital on their balance sheets to survive, but also to ensure they felt secure enough to begin lending to consumers, businesses, and each other again.
From 2002 to 2007, the size of the shadow banking system grew from $26 trillion in total global assets to $62 trillion. After a slight decline in 2008, the system began to grow again, leaving it at the $67 trillion mark it stands at today.
Since the crash, there’s been a vast amount of regulation aimed at addressing the shortfalls of the regular banking system — like Dodd-Frank and Basel III — but nothing to seriously curb the growth of the shadow banking system.
Naturally, the Financial Stability Board is calling for increased regulatory oversight: “The FSB is of the view that the authorities’ approach to shadow banking has to be a targeted one … to ensure that shadow banking is subject to appropriate oversight and regulation to address bank-like risks to financial stability.” Whether or not that will actually happen remains to be seen.
Money may not make the world go around, but it definitely makes goods and services circle the globe, which keeps businesses running, people employed, and taxes flowing into government coffers for essential services. As the FSB report argues, the continued lack of regulation in the shadow banking system puts all of that at risk.
Shadow Banking Grows to $67 Trillion Industry, Regulators Say
ReplyDeleteby Ben Moshinsky and Jim Brunsden
http://www.bloomberg.com/news/2012-11-19/shadow-banking-grows-to-67-trillion-industry-regulators-say.html
The size of the shadow banking system, which includes the activities of money market funds, monoline insurers and off- balance sheet investment vehicles, “can create systemic risks” and “amplify market reactions when market liquidity is scarce,” the Financial Stability Board said in a report, which utilized more data than last year’s probe into the sector.
ReplyDelete“Appropriate monitoring and regulatory frameworks for the shadow banking system needs to be in place to mitigate the build-up of risks,” the FSB said in the report published on its website.
While watchdogs have reined in excessive risk-taking by banks in the wake of the collapse of Lehman Brothers Holdings Inc. in 2008, they are concerned that lenders might use shadow banking to evade the clampdown. Michel Barnier, the European Union’s financial services chief, is planning to target money market funds in a first wave of rules for shadow banks next year.
The FSB, a global financial policy group comprised of regulators and central bankers, found that shadow banking grew by $41 trillion between 2002 and 2011. The share of activity based in the U.S. has declined from 44 percent in 2005 to 35 percent in 2011, moving to the U.K. and the rest of Europe.
Bypass Lenders
Supervisors consider shadow banking activities to be those that allow banks to carry out business off balance sheets, as well as those which allow investors to bypass lenders and the functions they traditionally fulfill on the markets.
The FSB also targeted repurchase agreements and securities lending for tougher rules, recommending that regulators implement minimum standards for calculating losses on the different types of collateral used in the transactions.
Repurchase agreements are contracts where one investor agrees to sell a security and then buy it back at a future date and a fixed price. Securities lending agreements involve institutional investors such as pension funds lending financial instruments against cash collateral.
The group is also concerned that regulators are unable to monitor the scale of the trades. Supervisors should “collect more data on securities lending and repo exposures amongst large international financial institutions with high urgency,” the FSB said in the report.
More Disclosure
Large firms should disclose more information about the deals to investors, the FSB said, and may be required to publish regular statements detailing how much collateral they have and what it is used for.
A bankruptcy examiner’s report found that Lehman used so- called Repo 105 transactions to move as much as $50 billion temporarily off its balance sheet to convince investors it wasn’t carrying too much debt.
Final rules will be submitted to leaders of the Group of 20 nations at a summit in St. Petersburg, Russia, next year, the FSB said. Mark Carney, chairman of the FSB, said earlier this month that regulators are holding “intense discussions” on shadow banks.
Shadow Banking: The $67 Trillion Threat to the U.S. Economy
ReplyDeleteby John Grgurich
http://www.dailyfinance.com/2012/11/20/shadow-banking-67-trillion-threat-economy/
Shadow banking. The name alone sounds ominous — like some dangerous phantom biding its time, waiting for the perfect moment to leap from its hiding place to do its deadly work.
On a financial level, that metaphor actually works pretty well.
The shadow banking system does exist in the shadows, away from the spotlight of regulation we’ve come to expect banks to operate within. And given the right conditions, it could leap unexpectedly from its dark, financial hiding place and bring the U.S. economy to its knees, just like it nearly did in 2008.
An Honor We’d Rather Not Hold
What’s bringing this issue to the forefront again is a new report by the Financial Stability Board, an international financial-standards advisory group. It cites that assets held in the global shadow banking system hit a new high last year: $67 trillion, which comes out to about half the world’s total banking assets.
In the report, the FSB formally describes the shadow banking system as “credit intermediation involving entities and activities outside the regular banking system.” Translated into English, this means the act of borrowing, lending, or otherwise shifting of money around by financial institutions that aren’t subject to regulation, like hedge funds. It can also refer to traditional banks operating in largely unregulated arenas such as credit-default swaps.
America’s portion of this $67 trillion in global assets is $23 trillion. In terms of total share, that’s a decrease from 44 percent in 2005 to 35 percent in 2011 — still enough to give the U.S. the dubious honor of having the world’s largest shadow banking system, and more than enough to put the entire U.S. economy at risk of another credit freeze.
That’s the danger here: Without the smooth flow of cash and credit, the lifeblood of any free-market system, economic life grinds to a halt.
What Refrigerators and Lehman Brothers Have in Common
If banks aren’t lending to consumers, there’s no one to buy Ford (F) cars, General Electric (GE) refrigerators, and Apple (AAPL) iPhones that keep those companies in business. And if banks aren’t lending to other businesses, when companies like Starbucks (SBUX) need to replace its aging fleet of latte machines or Southwest Airlines (LUV) its aging fleet of 737s, they won’t be able to borrow the capital to do so.
What happened in the fall of 2008 is that banks stopped lending to other banks — part of this shadow banking system. The now-failed Lehman Brothers was then very dependent on the interbank lending market (known to bankers as the “repo market”) to fund its day-to-day operations. But as fears grew that the Wall Street titan was overexposed to defaulting mortgage debt, other banks stopped lending to it. As a direct result, Lehman Brothers went bankrupt.
Once that happened, not only did the other big banks stop lending to each other out of fear they might go bankrupt if they didn’t hang on to every last drop of capital, they stopped lending to consumers and businesses, as well, beginning the economic chain reaction described above.
This is the point where the Federal Reserve and Congress stepped in to bail out the banks: not only to ensure that those that made it through the crash had enough capital on their balance sheets to survive, but also to ensure they felt secure enough to begin lending to consumers, businesses, and each other again.
$67 Trillion and Counting
ReplyDeleteFrom 2002 to 2007, the size of the shadow banking system grew from $26 trillion in total global assets to $62 trillion. After a slight decline in 2008, the system began to grow again, leaving it at the $67 trillion mark it stands at today.
Since the crash, there’s been a vast amount of regulation aimed at addressing the shortfalls of the regular banking system — like Dodd-Frank and Basel III — but nothing to seriously curb the growth of the shadow banking system.
Naturally, the Financial Stability Board is calling for increased regulatory oversight: “The FSB is of the view that the authorities’ approach to shadow banking has to be a targeted one … to ensure that shadow banking is subject to appropriate oversight and regulation to address bank-like risks to financial stability.” Whether or not that will actually happen remains to be seen.
Money may not make the world go around, but it definitely makes goods and services circle the globe, which keeps businesses running, people employed, and taxes flowing into government coffers for essential services. As the FSB report argues, the continued lack of regulation in the shadow banking system puts all of that at risk.