Promoting Risk Mitigation, Not Migration: A Comparative Analysis of Shadow Banking Reforms by the FSB, USA and EU

Abstract

The year 2013 is likely to be a watershed time in the development of shadow banking oversight and regulation. Of particular note, the FSB has commenced public consultations on its initial proposals and final recommendations are scheduled to be released in September 2013. Moreover, the US will soon begin designating its first nonbank SIFIs and will clarify its plans for regulating such entities in practice and the European Systemic Risk Board is preparing to recommend shadow banking oversight changes in early 2013. It is therefore an appropriate time to pause and re-evaluate the steps that have been taken thus far to address shadow banking at a national and global level. We find that, particularly in the USA, there has been an undue focus on identifying entities operating in the non-bank financial sector and a default to bank prudential regulation for such entities. This default response disregards other options available for risk mitigation, subjects diverse entities to a “one-size-fits-all” regulatory approach, and further complicates legal obligations for entities that are often already subject to other complex regulatory regimes. The consequence may be to potentially force risk migration rather than mitigation. We therefore advocate increased analysis of shadow banking activities, instead of current entity-based strategies imposing bank-like regulation. This approach allows for more effective identification of the sources of risk, greater uniformity in cross-border application of proposed reforms, and more flexibility in addressing financial innovation.We then examine two fiercely debated FSB workstreams: indirect regulation targeting bank interconnectedness and exposure to the shadow banking system and the proposed reforms of money market funds in the USA, EU and at the FSB. Both workstreams demonstrate the importance of tailored solutions that target the activities which create risk, rather than the application of uniform rules to shadow banking entities that ignore their unique characteristics, risk profiles and existing regulation.