* FSA urges radical rules to rein in shadow banks
* Draft shadow bank rules ready by year end
* Shrunk shadow banking gives regulators breathing space
By Huw Jones
LONDON, March 14 Regulators won't fully
understand the complexity of "shadow banks" and should therefore
opt for radical rule changes, Britain's Financial Services
Authority (FSA) said on Wednesday.
Policymakers say the opaqueness of the $60 trillion shadow
banking system - a web that includes money market funds,
securities lending and repos -- which operates alongside
mainstream lenders contributed to the financial crisis.
Leaders of the world's top 20 economies (G20) have called on
their regulatory task force, the Financial Stability Board
(FSB), to come up with draft rules by the end of this year.
The dangers of shadow banking were spotted over a decade ago
but little was done.
"This time we need to ensure that we are sufficiently
radical," FSA Chairman Adair Turner said in a lecture at the
Cass Business School.
"Any system this complex will defy complete understanding,
and any belief that we can precisely calibrate our response to
it will therefore be a delusion," said Turner, who also sits on
Instead, regulators should play safe with a "bias to
prudence" against such complex interconnectivity in the
Responses could include higher capital levels in the banking
system, ensuring that lenders hold bail-inable debt, and capital
requirements such as minimum initial margins on individual
The task of regulating shadow banks is challenging, not
least in defining what is shadow banking and exactly how it has
contributed to financial instability in the past, he said.
Shadow banking is not "something parallel to and separate
from the core banking system, but deeply intertwined with it".
The FSB has defined shadow banking as involving credit
intermediation outside the banking system and includes money
market funds, conduits, securitisation lending and repos.
Its recommendations may include capital charges and curbs on
a bank's exposure to shadow banks.
The European Union's executive European Commission will
begin consulting on possible rules for shadow banks in the
27-country bloc next Monday.
Turner said shadow banking, on some measures, is a shadow of
its former self following the collapse of securitised credit,
shrinking money market funds, and smaller investment bank
"And certainly the decline along these several dimensions
suggest that the immediate risks are smaller, allowing us time
to think through the appropriate policies," Turner said.
Instability from shadow banking was due to a combination of
mark-to-market accounting -- the pricing of bank assets at the
going rate each quarter, which can create volatility -- secured
funding and multi-chain maturity transformation.
The Volcker rule to ban proprietary trading at U.S. banks,
and planned extra capital around retail arms of UK banks will
help shield lenders from shadow bank vulnerabilities.
"But while these measures are all desirable, we should be
wary of considering them sufficient. A shadow banking system
could develop which would fully replicate banking system
leverage... harmful to both the macro economy and to the
resilience of the banking system," Turner said.