EU’s drive to cast light on ‘shadow banking’

The EU’s executive launched a consultation with industry yesterday with a view to writing rules to control shadow banking, a term describing activity resembling banks’ basic borrow-and-lend model, but often taking place beyond the watch of regulators.

It opens up a new front in the regulatory drive of Brussels, which some analysts believe has been slow to tackle the causes of a financial crisis that struck Europe almost five years ago.

“What we do not want is for financial activities and entities to circumvent existing and foreseen rules, allowing new sources of risk to accumulate in the financial sector,” said Michel Barnier, the EU official in charge of regulatory reform.

“That is why we need to better understand what shadow banking actually is and does, and what regulation and supervision may be appropriate.”

Political leaders are aware of the potential problem that shadow banking presents and the group of 20 top global economies have asked their taskforce, the Financial Stability Board (FSB), to come up with plans to regulate the sector.

That will provide a lead for the European authorities before finalising their plans.

The chairman of Britain’s Financial Services Authority, Adair Turner, is in favour of radical plans to regulate shadow banking, saying last week regulators should show a “bias to prudence”.

Hedge funds and private equity are often cited as examples of shadow banking, but the term can also take in investment funds and even cash-rich firms that lend government bonds to banks, and which in turn use them as security when taking credit from the European Central Bank.

Shadow banking can also refer to offshore vehicles such as those that banks used before the crisis for leverage, as well as money-market funds taking deposits from companies. The man credited with coining the term, former PIMCO managing director Paul McCulley, understood it to mean “the whole alphabet soup of levered up non-bank investment conduits, vehicles and structures”.