Emily Vogl, Frank Vogl
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IIF calls for a new approach to “shadow banking” debate
Regulators encouraged to take action to mitigate risks while preserving benefits of non-bank financial activities
Washington D.C., June 18, 2012 — The Institute of International Finance (IIF) today issued a report “Shadow Banking”: A Forward-Looking Framework for Effective Policy” calling for a new policy approach to non-bank financial activities sometimes described as “shadow banking”. The IIF focused on the potential benefits and risks of these activities and the most appropriate use of risk mitigation tools.
Mr. Douglas Flint, Chairman of the Board of Directors of the IIF, and Group Chairman of HSBC, said, “Today, the IIF releases its first report on policies concerned with non-bank financial activities. The report, developed under its Special Committee on Effective Regulation, recommends the adoption of a differentiated approach to this disparate range of activities, carefully considering each on its own merits to assess whether, and if so how, they could create systemic risks, rather than addressing them collectively as ‘shadow banking’.”
Mr. Peter Sands, Chairman of the IIF’s Special Committee on Effective Regulation, Group Chief Executive Standard Chartered plc., said, “We welcome the work of the global regulatory community on developing an internationally consistent approach to ‘shadow banking’. Industry and regulators should take a proportionate, activity-by-activity approach to non-bank activities that present specific risks to investors, financial stability or the wider economy, whilst seeking to preserve the benefits non-bank finance can provide.”
IIF Managing Director Mr. Charles Dallara, said, “There could well be a significant expansion of non-bank financial activities as a direct result of the increasing level of banking regulation that we are now seeing. It will be important to monitor the implications of this for systemic risks.”
The IIF Report agreed with the FSB that the financial crisis showed the substantial and potentially systemic risks that can be posed by some non-bank financial activities and by their connections through the financial and banking systems. Addressing these issues is urgent to the extent that post-crisis reforms by regulators and industry, such as the new minimum risk retention requirements in the EU and US for securitization, have not done so already.
Nevertheless, the IIF Report stressed that properly structured and with risks properly managed, non-bank financial intermediation provides significant benefits to investors, borrowers and the wider economy. It is becoming widely recognized for example that securitization, securities lending and repo in the EU as well as the US will be essential for recovery to take place at a time of bank deleveraging that is largely driven by new regulatory requirements.
Mr. Edward Greene, Chairman of the IIF Shadow Banking Advisory Group, Senior Counsel, Cleary Gottlieb Steen & Hamilton LLP, stated, “The debate must go beyond applying the ‘shadow banking’ label to very different non-bank financial activities. Policy makers should avoid acting on the mistaken assumption that these activities have the same characteristics, type and level of risks, and call for the same forms of risk mitigation.”
“When regulators judge that an activity poses specific risks, they should use risk mitigation tools. Prudential regulation may be needed in some cases, but there are other tools, ranging from targeted communication and improved disclosure of risks to investors to the use of conduct of business regulation and macroprudential policy, that may be more effective in others. Regulators should take an activity-by-activity approach and use whichever tool is likely to be the most effective and proportionate.”
The IIF Report suggests that any policy framework be based on three stages of action: first, the identification of relevant activities and collection of relevant information about them, second, an assessment of whether they could pose systemic risk, and third, if risks are identified, the use of risk mitigation tools.
On the collection of information, the IIF Report agrees with the FSB’s approach of beginning by casting a wide net to collect data before narrowing its focus to those activities that could increase systemic risk. The IIF said that it is important that authorities have access to high quality, relevant data and that while the industry should be open in supplying it, supervisors should carefully consider if indirect data collection from banks is the best way to obtain that information. Regulators and supervisors should ensure that information is collected in the most efficient manner possible. It should be made clear that gathering information is not an automatic precursor to new or additional regulation but the basis for analysis of, and dialogue on, potential risks.
The IIF has developed a template to assist with risk assessments that could be used by macroprudential oversight bodies, regulators and supervisors. This template looks, for example, at the degree to which potential risks in an activity are already reduced as a result of disclosure, risk management practices, transparency or regulation.
As a way of demonstrating the value of the IIF’s proposed template, testing it against real-world examples, the Shadow Banking Advisory Group carried out six case studies on non-bank financial activities. The results of these are set out in an annex to the Report.
Mr. Greene said, “Financial institutions need to work with regulators and supervisors to manage risks effectively; to alert them to concerns and provide information to help them assess risks; and to cooperate on the design and implementation of regulation and other forms of risk mitigation. This paper should be seen as strong commitment by the industry to such an undertaking.”
Today’s report is published at a time when the authorities are strengthening their focus on non-bank financial activities. The Financial Stability Board responded to a call to strengthen “shadow banking” regulation and oversight by G-20 leaders by publishing a report in October 2011: “Shadow Banking: Strengthening Oversight and Regulation.” The FSB set out both a monitoring and data collection framework and proposed regulatory measures to address concerns, based on five workstreams, all of which are due to be completed before the end of 2012. In addition, a number of jurisdictions have or are in the process of addressing policy issues that “shadow banking” presents, including the European Commission, which has recently issued a Green Paper, to which the IIF has also responded.
Emily Vogl, Frank Vogl