The overall picture of financial capitalism is changing. The next big crisis could come not from the traditional banks, which have been the focus of financial market regulation to date, but from the "shadow banks". For a long time, no significance was attached to companies in the shadow banking sector. On the contrary, less dependence of the economy on banks was seen as an advantage, especially in the light of the financial market crisis, where states supported "their" banks with billions of euros from their budgets.
by David Stein: from sozonline.de
What are shadow banks?
In the fall of 2007, investment manager Paul McCulley used this catchy term to describe for the first time the part of the financial system in which he suspected huge dormant risks even before the great financial crisis, without this being problematized in the public debate or even leading to regulatory consequences. Since then, this term has become firmly established in the financial sector, in politics and among economists. It said it wants to understand what is going on in the shadows, off bank balance sheets and opaque to regulators. This has been the credo since 2007.
In the eleventh year since the financial crisis began, it is apparent that little progress has been made in understanding and reaching a G20 consensus on the politically connoted concept of shadow banks, and international regulatory standards are still miles away.
The Financial Stability Board (FSB), established by the G7 countries in 2009 and expanded by the G20 countries, had set itself precisely this objective. In this sector, it should identify the weaknesses of the international financial system, make proposals to the G20 to eliminate them, and monitor their implementation. He initially defined the shadow banking system relatively broadly as "credit intermediation by activities and entities outside the regular banking system". In the meantime, they are rowing back. The FSB has recently been asked to focus only on non-banks that engage in credit-like activities which it considers to be systemically important and to pose a threat to financial stability.
All credit transactions that are not conducted through institutions with a banking license are in principle to be classified as belonging to the broad world of shadow banks. Before the financial crisis, it was mainly the banks themselves that were able to hide risks in subsidiaries that did not appear in any annual report. New international rules have since made such trickery more difficult. However, these only apply to banks. These sectoral regulations have not minimized the risks to the financial system as a whole, but merely shifted them further into the darkness of the shadow banks. Shadow banks have benefited from increased regulation of banks since the financial crisis, which are now required to back their operations with more capital and – unlike shadow banks – must comply with disclosure requirements to supervisors.
Banks have long since ceased to be the sole masters of money: In their search for returns, other financial service providers are increasingly entering the traditional financial business of credit institutions – such as money market funds, investment funds and hedge funds. The shadow banking sector consists of a heterogeneous group of institutions and business models that, at first glance, do not necessarily have much to do with each other and are subject to different accounting rules. The FSB's latest global shadow banking report, published in March 2018, shows that the world's shadow banks, which are still barely regulated, further expanded their share of the overall industry after the 2007 financial crisis.
Shadow banks move an increasing volume of assets. The FSB now puts the actual risky part of the financial markets beyond the conventional banks at $34 trillion. This is 3.2 percent more than the year before and corresponds to around 70 percent of the total gross domestic product of the countries it examines. In previous FSB reports, the financial gray market had been defined much more broadly: As recently as 2015, the FSB had reported its volume at $75 trillion. In the meantime, however, he narrows down the field to those transactions on the market from which, in his opinion, real risks for the global financial system are to emanate.
The activities of such shadow banks, judged to be systemically important, now comprise 13 percent of financial assets in the 29 countries the FSB has studied. However, many countries did not provide data, so they do not appear in the study. These can be hedge funds or private equity funds, but also pension funds or insurers.
Given the scarcity of capital and tighter regulation of banks, the incentive to move capital into the shadow banking system has increased. Globally, the total volume of shadow banks, including "non-systemic" entities, is estimated at $149 trillion. In 2002-2011 alone, the total assets of shadow banks more than doubled to about $67 trillion, according to FSB data.
In the U.S., shadow banks, which are assumed to pose systemic risks, account for more than one-third of the entire financial system, with a volume of $14.1 trillion; according to the Bundesbank, in Germany the total assets of these shadow banks are equivalent to 15 percent of the total assets of regulated banks. In China, the volume of shadow banking is $7.7 trillion (or 15 percent of total assets), followed by the $4.7 trillion offshore center of Cayman Islands, which first provided data to the FSB in 2017.
Since it is almost impossible for Chinese small and medium-sized enterprises as well as private individuals to obtain a loan from one of the state-owned banks, a huge gray financial market has emerged in China via credit platforms through which private individuals and dubious companies have extended loans, many of which have turned out to be of no value and to which depositors have provided money in exchange for "guarantees" of no value. Many speculators have lost money. The Chinese government has now pulled the emergency brake to prevent systemic risk, banning widespread speculative financing of all kinds. For years, this "second financial market" was praised by Chinese economists as a lubricant for high growth rates and tolerated by the state.
Where the risks lie?
Shadow banks are risky for the equilibrium of the financial system if, like banks, they collect funds from investors and grant loans. This is especially true for those providers that operate with particularly high leverage ratios or that z.B. lend to a large extent on a long-term basis, which could draw their investors away from them in the short term. 65 percent of risky shadow banking activity is attributed by the FSB to investment vehicles that collect investor funds and reissue them in the form of loans.
The problem with such players is: they can be vulnerable to panic situations in financial markets, such as when investors can withdraw money from them at will in the short term, which can force funds to engage in distress sales when money is invested for the long term. The share of providers vulnerable to such risks has grown by an average of 13 percent per year since the end of 2011. All in all, investment vehicles such as open-ended bond, credit or hedge funds account for 72 percent of shadow banks. The collapse of these shadow banks could put global financial markets at risk, in the FSB's view.
Targeted global regulation
The policy demands against shadow banking are simple to formulate: The existence of a shadow banking sector is nothing more than an invitation to regulatory avoidance. There should therefore be no company with bank-like activities without bank-like regulation. Same rules must apply to same business. They have the same requirements in terms of transparency and transparency of the financial system. Disclosure of trades, risk management, liquidity and equity, and to orderly resolution in the event of insolvency, which also apply to the regular sector.
Uniform standards must apply to all activities, products, and players in the financial markets, whether or not an entity has a banking license, whether it belongs to the shadow banking sector in the narrow or broader sense, and regardless of the country in which it is headquartered. Therefore, the shadow banking sector needs to be included in regulatory havens (synonymous with tax havens) and dried up at the interface where regulated banks enter into a business relationship with unregulated shadow banks and where supervisors are therefore well placed to intervene.
The fact that the FSB, after almost ten years, is unable to indicate how and by what methods systemically important shadow banks should be identified in the future, and that it has not yet presented a finished regulatory concept, has less to do with the complexity of the problem. Rather, the reason is to be found with the regulation deniers. The U.S. has blocked all regulation so far except for a list of systemically important players and a better reporting system. The same is true for the UK, which would prefer to back out of EU-level regulations such as investment funds so that the City of London becomes even more attractive to dark capital.
The European Commission also presents a pitiful picture. Instead of touting its regulatory model for specific sectors as a first approach to global regulation, it has so far attracted attention only by making one demand: Because of the negative connotation of the term "shadow banks," it would be preferable to speak of "market-based finance".
Thus, given the balance of power among states and the absence of public regulatory pressure, skepticism is warranted in the FSB's, and thus the G20's, next steps. The time bomb will not be defused by the G20 in the foreseeable future with their eyes open. The child must first fall into the well again, as in 2007.