There is much confusion about what shadow banking is and why it might create systemic risks. This column presents shadow banking as ‘all financial activities, except traditional banking, which require a private or public backstop to operate’. The idea that shadow banking is something that needs a backstop changes how we think about regulation. Although it won’t be easy, regulation is possible.Vox.eu
What is shadow banking?
Stijn Claessens, Assistant Director in the Research Department of the International Monetary Fund, Professor of International Finance Policy at the University of Amsterdam and CEPR Research Fellow, and Lev Ratnovski, Economist, Research Department, IMF
5 comments:
I've not seen any posts here on MNE about the turmoil being created by US and EU regulators in the Repo markets, one of the largest shadow banking markets there is. They are actually regulating -- imagine that -- one of the largest shadow banking markets while at the same time shrinking it. The stocks and flows in the market have fallen dramatically but I'm not sure how the reduction in financial credit will play out in the real economy. Sort of depends on what type of transformation is being performed in the market by most participants. Risk, Duration, Rate, who knows.... The dollar amounts and reduction in overall credit should be headline news. Sort of an obscure market to the general public but incredibly important to banks, brokers, money markets, government, reits, emerging markets.... plenty of real economy participants.
http://online.wsj.com/article/SB10001424127887323608504579023310719697846.html
http://ftalphaville.ft.com/2013/08/21/1608313/repo-markets-and-the-supplemental-leverage-ratio/
http://www.livemint.com/Money/v0dZc3FzhAhj77jUf3s1OM/Repo-market-decline-raises-alarm-as-regulation-strains-debt.html
http://ftalphaville.ft.com/2013/05/20/1508332/collateral-crunch-counting-gets-sophisticated/
http://ftalphaville.ft.com/2013/05/07/1489382/how-to-kill-the-european-repo-market-in-10-easy-steps/
http://www.jpmorgan.com/cm/ContentServer?c=TS_Content&pagename=jpmorgan%2Fts%2FTS_Content%2FGeneral&cid=1310320562046
Increasing regulation, capital requirement, etc, raises costs and increase "inefficiency." This is why banks and other financial institutions hate it and lobby hard against it. Reducing liquidity means reducing leverage, therefore, profit potential. the tradeoff for being macro-prudential and reducing risk. But the banks would have it that the sky is falling.
Basic problem is that modern capitalism requires externalities to socialize costs and welfare in the from of government deficits and bond issuance to support firm profits. Modern capitalism also requires low wages to achieve the expanding profit share that financial markets have come to expect.
When the prospect of the game changing even minimally through regulation is raised, then business claims that the end of the world is nigh.
The end of the world of capitalism may be nigh but not for that reason. It's the innovation, or rather lack of it according to Robert J. Gordon, Is U.S. Economic Growth Over? Faltering Innovation Confronts The Six Headwinds (NBER)
The crucial question is how to prevent socialisation of losses (by shadow banks or other entities). That can largely be achieved, as explained by Matthew Klein, Laurence Kotlikoff and others, by banning the basic activity carried out by banks for centuries: promising to return SPECIFIC SUMS OF MONEY to depositors and other bank creditors, while investing that money in ways that are bound to mean that sooner or later that money just cannot be returned. I.e the reality is that any bank will sooner or later make a series of silly loans, and for centuries the reality is that banks have failed with monotonous regularity.
The solution, as explained e.g. by Mathew Klein, is to force depositors and bond holders to be responsible for losses where those depositors or bond holders want interest: i.e. want their money to be loaned on or invested by their bank. Article by Matthew Kline here:
http://www.bloomberg.com/news/2013-03-27/the-best-way-to-save-banking-is-to-kill-it.html
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