20 October 2014

Wall Street Journal: Europe should regulate shadow banking, says European Central Bank’s Vitor Constancio

Speaking during a conference on the future of banking at Chatham House, home of the Royal Institute of International Affairs in central London, Mr. Constancio noted that while European bank assets have declined by 11% since the end of 2012, assets managed by investment funds had risen by 30%.

As part of the European Union’s creation of a banking union, the ECB will next month take over responsibility for supervising 120 banking groups across the bloc. But Mr. Constancio’s comments suggest the Frankfurt-based institution is already looking beyond its new role and toward other parts of the financial system.

Mr. Constancio said that tighter regulation of banks in the wake of the financial crisis has led to a migration of some activities to the nonbank sector, such as hedge funds, which aren’t formally regulated.

In particular, Mr. Constancio said regulators should find ways to ensure banks don’t lend too much to shadow banks, and won’t be threatened should some shadow banks get into difficulty.

He also said that Europe should follow the lead of the U.S. and regulate some financial firms that don’t take deposits, such as insurers or the financial arms of large corporations.

The U.S.’ Financial Stability Oversight Council has already designated the GE Capital financing arm of General Electric Co. and the insurers Prudential Financial Inc. and American International Group, as systemically important, which potentially subjects them to tougher capital rules and other new regulations.

Leading regulators from around the world believe they have completed many of the overhauls needed to fix the deficiencies exposed by the financial crisis, and hope they will be approved by leaders from the Group of 20 largest economies when they meet in Australia next month.

But regulating the shadow banking system won’t be easy. Earlier this month, Bank of England Deputy Governor Jon Cunliffe said regulators don’t know enough about the system to conclude that it is likely to be the next threat to the stability of the financial system, but they need to do “a lot more work” before they can conclude that it isn’t.

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