* Commission explores controls of non-bank credit activity
* Shadow banking doubled in past decade
* EU's Barnier seeks definition of unchartered sector
By John O'Donnell
BRUSSELS, March 19 The European Commission is
widening its regulatory sweep to include "shadow" banking,
heralding new controls over the sprawling and largely
unchartered 46 trillion euro ($61 trillion) sector that has been
blamed for helping trigger the financial crisis.
The EU's executive launched a consultation with industry on
Monday with a view to writing rules to control shadow banking, a
term describing activity resembling banks' basic borrow-and-lend
model, but often taking place beyond the watch of regulators.
It opens up a new front in the regulatory drive of Brussels,
which some analysts believe has been slow to tackle the causes
of a financial crisis that struck Europe almost five years ago.
"What we do not want is for financial activities and
entities to circumvent existing and foreseen rules, allowing new
sources of risk to accumulate in the financial sector," said
Michel Barnier, the EU official in charge of regulatory reform.
"That is why we need to better understand what shadow
banking actually is and does, and what regulation and
supervision may be appropriate."
Political leaders are aware of the potential problem that
shadow banking presents and the Group of 20 top global economies
have asked their task force, the Financial Stability Board
(FSB), to come up with plans to regulate the sector.
That will provide a lead for the European authorities before
finalising their plans.
The chairman of Britain's Financial Services Authority,
Adair Turner, is in favour of radical plans to regulate shadow
banking, saying last week regulators should show a "bias to
Hedge funds and private equity are often cited as examples
of shadow banking, but the term can also take in investment
funds and even cash-rich firms that lend government bonds to
banks, and which in turn use them as security when taking credit
from the European Central Bank.
Shadow banking can also refer to offshore vehicles such as
those that banks used before the crisis for leverage, as well as
money-market funds taking deposits from companies.
The man credited with coining the term, former PIMCO
managing director Paul McCulley, understood it to mean "the
whole alphabet soup of levered up non-bank investment conduits,
vehicles and structures", such as the special investment
vehicles that many blamed for the financial crisis.
The sector, which operates on the fringes of mainstream
banking, has more than doubled in size over the past decade and
accounted in 2010 for more than a quarter of the total financial
system and is half the size of all bank assets.
Many fear that as the regulatory net closes in on banks,
activity will migrate into shadow banking, building up new
financial bubbles that could burst in the future.
The European Union regulation will be cast within the FSB's
broad framework, although there is always scope for them to
sharpen certain rules. The difficulty in agreeing on an exact
definition, however, may undermine attempts to regulate it.
"Many institutions such as hedge funds act similarly to
banks when, for example, they buy corporate bonds or lend to
companies using the funds of investors or savers," said Graham
Bishop, an expert in EU regulatory policy.
"And they face similar risks, often borrowing on a
short-term basis and lending over a longer term, making them
vulnerable to short-term funding risks."
The Commission, which writes the first draft of EU laws
before seeking the green light from the bloc's 27 member states
and the European Parliament, said it was focusing on asset
management, securities lending and repurchase agreements,
securitisation, and other shadow banking entities.
Ultimately, it may be down to national and pan-European
regulators to keep tabs on the ever-changing sector. This could
prove difficult to agree on with countries such as Britain
reluctant to see further powers given to pan-European financial
"If you seek to define shadow banking, it will migrate to
escape regulation," Bishop said. "We need to give regulators
more leeway to ask if activities like these are something that
poses a risk to the financial system."