Exchange traded funds in the shadow banking system

Abstract

Shadow banking involves functions of banking being performed by entities or channels other than banks. The Financial Stability Board (FSB) defined shadow banking in 2011 as ‘the system of credit intermediation that involves entities and activities outside the regular banking system’. That definition only takes us so far. How best to capture the nature of shadow banking, so as to mark out a coherent supervisory domain, has been an ongoing issue since the 2007–08 crisis. This definitional issue both informs and is informed by policy responses to the rapid growth of this part of the financial system over the last two decades. Exchange traded funds (ETFs), like many other forms of collective investments, sit at the still-contested frontier of that domain. In its 2012 Green Paper on shadow banking, the European Commission included ‘investment funds, including Exchange Traded Funds (ETFs), that provide credit or are leveraged’ in its list of possible shadow banking entities. Subsequently, the FSB has focused its monitoring efforts on the economic functions performed by shadow banking; and relevant functions include the management of collective investment vehicles with features that make them susceptible to runs. The FSB concluded in 2015 that such vehicles (which include money market funds and hedge funds) represented 60 per cent of all shadow banking, now eclipsing both the size and the rate of growth of the function of securitisation.