Combatting the Dangers Lurking in the Shadows: The Macroprudential Regulation of Shadow Banking

Abstract

Since the 2008/09 financial crisis, the international regulatory community has taken steps to reduce the probability of future significant financial instability. So far, the emphasis has been on tougher capital and liquidity regulations for banks and greater transparency for financial products, and greater regulation of financial infrastructure such as central counterparties, trade repositories, and the clearing of over-the-counter derivatives. To mitigate the risks of another run on the shadow banking system greatly amplifying financial instability, some shadow banking entities ought to be regulated as banks or in a similar fashion to banks (for example, with capital and liquidity requirements) while in other cases regulation should cover banks’ relationships with them, their procyclical behaviour in certain markets (such as those for repos), or the ratings process for securitized products. Because of the diversity of the various parts of the shadow banking system, the policy responses proposed in this study differ significantly across those parts. Taken together, the implementation of these policies should help reduce systemic risk and the probability of future periods of financial stress, for a stronger and more stable financial system.