5th Aug 2020

EU clamps down on shadow banking

  • The EU Commission has denied taking aim at money market funds (Photo: Travel Aficionado)

EU financial services commissioner Michel Barnier on Wednesday (4 September) laid out plans to regulate the opaque shadow banking sector, saying that it should no longer be beyond "clear supervision."

The shadow banking sector sees firms offering bank-like credit services, involving a range of financial products, but doing so outside the regular banking structure.

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The total value of shadow banking assets held across the world is estimated at €51 trillion, representing over 25 percent of the total financial system. Of this, eurozone countries account for €16.8 trillion while the UK accounts for €6.8 trillion.

Barnier said that he was "not pointing an accusing finger, but it should work smoothly´."

"Nobody should be able to escape the clutches of clear and efficient supervision," he added.

First in the commission's line of fire are money market funds (MMFs), used by banks and big companies to invest their surplus cash for short periods of time. Firms see MMFs as an easy way to turn quick profit, while regulators are concerned that the funds are too interconnected with the banking sector.

The commission wants all funds domiciled or marketed in the EU to build up capital buffers worth at least 3 percent of the assets they manage, leaving them better equipped to absorb losses if large numbers of panicked investors try to get their money at the same time.

Commission officials indicated that the 3 percent capital requirement would guard against a run on a fund, highlighting a case where the value of one U.S. fund "broke the buck" and fell below $1 per share.

"What makes them so dangerous is the trigger point," one official noted, adding that without establishing capital buffers the funds "cannot honour their promises if there is a serious default event."

The regulation would also require funds to keep a minimum amount of liquid assets and place limits on their investments.

However, the proposal does not go far enough for France and Germany, nor for the European Systemic Risk Board (ESRB) - an EU agency tasked with identifying potential dangers to financial market stability.

The ESRB warned that money market funds constituted a "considerable risk" to market stability and advocated a total ban.

"I'm not here to shuffle paper for council (representing member states) and the European Parliament," said Barnier when questioned on the matter, adding that "we believe that this is something that is important to our economy rather than a formal and brutal ban."

The commission's proposals were "very well designed", Frederic Hache, an analyst with Finance Watch, told EUobserver, adding that shadow banking had played "a very big part" in driving the 2008 financial crisis.

"Shadow banking is so interconnected with the regular banking sector that contagion spreads very quickly", he said.

He also dismissed the suggestion that the regulation would drive money market funds away from the EU.

"The cash buffer may reduce the attractiveness of funds with a constant net asset value relative to other funds but the new framework should make money market funds in general more robust and attractive to investors," he said. 

The issue is also on the agenda at this week's G20 meeting in St. Petersburg. Finance ministers are expected to back recommendations on how to regulate the sector by the Swiss-based Financial Stability Board (FSB).

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