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13th Aug 2022

EU still unsure what 'shadow banking' really is

  • Easy credit and mortgages were one of the causes of the 2008 financial crisis (Photo: Jeremy Brooks)

The EU is considering new rules on so-called shadow banking - unregulated investment funds and mortgage institutions - but it still has to define exactly what type of financial activities it covers.

"Shadow banking is a parallel banking system for which we do have to create effective regulation and supervision, otherwise the financial markets may well transfer part of their activities and products to this unregulated market and increase the risk of new crises," financial markets commissioner Michel Barnier said Monday (19 March).

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Five years after the collapse of the Lehman Brothers investment bank, which triggered the global financial crisis, the EU commission is still working on regulation aimed at curtailing risks in the financial markets.

Shadow banking - a term encompassing simple services such as mortgages, loans given without deposit, and complex investment schemes run by hedge funds - represents some 25-30 percent of the world's banking sector and its share is increasing in Europe, Barnier said.

"We have to define the term firstly. We want to act, but first we need to understand it and to see if our list is complete," the commissioner said.

Asked if he was concerned that the slow response after the 2008 crisis still leaves Europe exposed to risks, Barnier said: "Yes, I am concerned. We are still learning the lessons of Lehman Brothers. We are not out of the woods yet, we have to be honest about it."

He admitted that the legislative process is "slower than the markets", since it takes over a year to adopt new legislation from the moment it has been tabled.

Barnier said that amendments to existing legislation or draft legislative proposals may be tabled by the end of the year so as to cover all 'shadow banking' activities.

But German investment funds have criticised the commission's approach. The German Association of Investment and Asset Management (BVI) said oversight of unregulated financial instruments and institutions was overdue, but its head, Thomas Richter, said investment funds are already covered by other legislation. "Our industry certainly cannot complain about a lack of regulation," he said in a statement.

One expert in financial services told this website that the consultation paper reflects a US view that these services are not regulated at all.

"The question is what they mean by shadow banking. In the US, shadow banking concentrates on products that are highly regulated here in Europe. So this exercise is totally useless," Diego Valiante from the Brussels-based Centre for European Policy Studies said.

In the US, treasury secretary Timothy Geithner earlier this month warned against the risks posed by this sector: "A large shadow banking system had developed without meaningful regulation, using trillions of dollars in short-term debt to fund inherently risky financial activity."

The commission plans to end the consultation by 1 June and organise a conference on shadow banking on 27 April.

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