Rapid growth of shadow banking calls for regulatory response, says IMF
A recent pickup in shadow banking activity has prompted the International Monetary Fund to ask whether tightening of banking regulation around the world is forcing risky financing activity out of regulated banking markets and into the shadows.In a report published this week, the IMF said the current financial environment in advanced economies was conducive to further growth in shadow banking, with increased compliance costs and legal risks affecting banks' willingness to lend to small businesses or provide leveraged loans, project finance or hedging facilities.The IMF has recommended that policymakers look at widening their regulatory perimeters to capture more shadow banking activities.The IMF's view is that shadow banking can play a beneficial role in an economy, as a complement to traditional banking by extending access to credit or by supporting market liquidity, maturity transformation and risk sharing.However, it can make a disproportionate contribution to systemic risk, as it did in the United States during the financial crisis.The IMF said: "The global financial crisis revealed that, absent adequate regulation, shadow banking can put the stability of the financial system at risk in several ways."These risks included high leverage, illiquidity, complexity and procyclicality.It said the contribution of shadow banking to systemic risk in the United States currently was "substantial", although below pre-crisis levels. Risks in the UK and the euro zone were "modest."The IMF estimated that shadow banking assets in the US were equivalent to 180 per cent of banking assets. The proportion was much lower in other markets - about 60 per cent in the euro zone, 50 per cent in the UK and around 20 per cent in other advanced economies (Australia was not listed separately).These figures cover finance companies, microcredit lenders, various types of managed funds providing credit, securitisation and other structured finance vehicles, money market funds and a newcomer - peer-to-peer online lending platforms.Shadow banking assets, relative to regulated banking assets, have grown over the past couple of years in all markets surveyed by the IMF and are expected to grow further. Emerging market economies, particularly China, are hotspots.On the demand side, growth is being fuelled by investors' willingness to take higher risks in the search for higher yielding assets.Regulatory measures taken since the financial crisis include more detailed disclosure of asset valuations, improved governance and ownership reforms.Further measures canvassed in the IMF report include the application of bank-like capital requirements to shadow banks, redemption limits on managed funds to stop runs, and restrictions on the development of certain types of instruments.Central bank lender-of-last-resort funding could be extended to shadow banks, although this would entail moral hazard.Changes to bankruptcy laws may be required to provide "specific recovery and resolution tools" needed to manage the risks involved in shadow banking failures."Monitoring and risk identification should focus primarily on economic functions and activities, but regulation and supervision have so far mostly focused on entities. Doing so may help overcome the boundary problem and reduce the scope of regulatory arbitrage," the IMF said.