Promoting risk mitigation, not migration: a comparative analysis of shadow banking reforms by the FSB, USA and EU

Abstract

In the aftermath of the financial crisis, there has been an unfortunate default to bank prudential regulation for ‘shadow banking’ entities. Shadow banking reform efforts have unduly emphasized the identification and regulation of non-bank entities, instead of a more constructive focus on their activities. Efforts to regulate shadow banking, particularly in the USA, too often subject diverse entities to a ‘one size fits all’ regulatory approach, ignoring the different causes of risk, and further complicating legal obligations for entities that are often already subject to other complex regulatory regimes. Alternatives to prudential regulation, such as non-regulatory and conduct-of-business tools, as well as improved disclosure requirements, are regrettably absent in the efforts to date of the Financial Stability Board (FSB), USA and EU. While the FSB and EU have initiated their shadow banking reform efforts by first addressing shadow banking at the macro level, the USA reforms have focused on non-bank systemic entities and activities and avoided the term and concept of ‘shadow banking’. Although the FSB, USA and EU have taken positive steps to address the interconnectivity of regulated commercial banks and non-bank institutions, international coordination and carefully tailored rules are key to preventing the movement of risk outside the regulated banks to the more opaque shadow banking sector. Despite US and EU reform efforts, money market mutual funds (MMFs) remain vulnerable and highly responsive to market shocks. Still, any proposal to strengthen MMF resiliency must target the primary cause of the 2008 run—first-mover advantage and shareholder incentive to redeem.