01 October 2018

Financial Times: Policymakers share blame for the shadow banking boom

Ten years after the world was rocked by an unprecedented banking crisis, policymakers are sounding the alarm about the spread of risk out of the now more regulated banks and into the “shadows” where asset managers, insurers and others carry out banklike business.

First came Mario Draghi, ECB president. A fortnight ago he pointed out that the non-bank financial sector in the EU now harboured €42tn, or 40 per cent, of the region’s entire financial system. Its rapid growth highlighted that “commensurate additions to the policy toolkit” were clearly needed. Translated out of central banker speak: he lacks the powers to deal with these burgeoning risks.

Next came François Villeroy de Galhau, the Banque de France governor, who cited the same figures but added a touch of politics by blaming “the big investment funds, they are partly American” and admitting “it’s been a bit forgotten as [bank] regulation has been strengthened”.

Finally, last week, Peter Praet, the ECB’s chief economist, said that he was particularly worried about “the degree of leverage in the financial system . . . because of the shadow banking system”.

The warnings felt like a co-ordinated expression of ECB concerns. They were all the more worrying because of Mr Draghi’s suggestion that regulators lack the powers to deal with this expanding sector.

Yet, it is policymakers themselves who must take at least some of the blame for creating these shadowy risks — and on three counts.

First, their regulatory crackdown on banks in the aftermath of 2008 may well have derisked those institutions by boosting equity, thus cutting leverage. But it displaced many of the risks to non-banks.

Second, those risks have been inflating fast. Spurred by ultra-low interest rates and quantitative easing, investors have been ploughing funds into asset managers that might be able to generate better returns than pitiful risk-free rates. As a result equities, junk bonds, real estate and many more asset classes are in bubble territory in large parts of the world.

Third, policymakers have done little to curb mounting non-bank risk despite years of evidence. Back in 2011, the G20, architect of the initially successful global response to the crisis three years earlier, ordered the Financial Stability Board, which oversees global rulemaking, to come up with an assessment of non-bank financial groups deemed “too big to fail”. Yet, after four years of procrastinating — and frantic lobbying by those non-bank financial groups — the FSB concluded that asset managers, which account for the lion’s share of non-banks, were not systemic.

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