How to tackle shadow bankers?

Prof. dr. Dirk Schoenmaker

Dean, Duisenberg school of finance

FSA Congres, 28 April 2011

What is shadow banking?

• Shadow banks are financial institutions that provide credit and do maturity transformation without access to central bank or deposit insurance

• So, banks that are not “officially” banks

• Examples: finance companies, structured investment vehicles, asset-backed paper vehicles, credit hedge funds, money market mutual funds, etc.

Law of communicating vessels

Why is it unknown?

• Cultural based explanation

• Shadow banks are operating in the shadow

• Hedge funds, etc are happy to keep low profile

We all focus on the well-known: banks and insurers

Where do people look?

Why is shadow banking a problem?

Credit is growing outside traditional banking system

What is the problem?

Problem

• Credit is driving consumption and asset prices

• “Unobserved” credit growth was driving housing and equity bubble in the US

What do our problem-solvers do?

• How do central bankers and supervisors look at the banks under their supervision?

Do they look at the trees?

Or at the forest?

The macro- and microprudential perspectives compared

Macroprudential Microprudential

Proximate objective limit financial system-wide

distress limit distress of individual

institutions

Ultimate objective avoid output (GDP) costs

linked to financial instability consumer (investor/depositor)

protection

Characterisation of risk Seen as dependent on

collective behaviour (“endogenous”)

Seen as independent of individual agents’ behaviour

(“exogenous”) Correlations and common exposures across institutions

important irrelevant

Calibration of prudential controls

in terms of system-wide risk; top-down

in terms of risks of individual institutions; bottom-up

Macro- vs. Micro-Macro- vs. Micro-prudential regulationprudential regulation

We need a system perspective

Solution• Not more micro-rules (which will be circumvented)• But take a system-wide perspective• Look at credit growth at banks and at market based

shadow banks

At Duisenberg school of finance• We take an integrated system approach in our

Master in Finance Programmes• We are active in search for new macro-prudential

tools -> on top of our research and teaching agenda

Solutions

1. Monitor banking (credit growth) at system level- Fed New York started thinking in 2009- The ECB has just recently (2011) decided to

look at shadow banking in Europe

2. Design macro-prudential tools with system-wide reach

- Loan-to-value ratios for mortgages- Margin requirements for equity

Conclusions

• Traditional focus on banks, which are only part of the financial system

• Challenge: To monitor credit growth at shadow banks To design macro-prudential tools that work system-wide

• But focus still on micro-prudential rules for banks (Basel III) -> reinforces shift to shadow banking

• We need some “out of the micro-box” thinking at central banks!

Background reading

• Adrian and Shin (2009), The Shadow Banking System: Implications for Financial Regulation, Federal Reserve Bank of New York Staff Reports, No. 382.

• Pozsar, Adrian, Ashcraft and Boesky (2010), Shadow Banking, Federal Reserve Bank of New York Staff Reports, No. 458.

• Oliver Wyman (2010), The Financial Crisis of 2015: An Avoidable History.

• Financial Stability Board (2011), Shadow Banking: Scoping the Issues.