Shadow Banking set for stellar 2015?

Shadow Banking in 2015Fed Vice Chair Stanley Fischer’s warning about the “unintended consequences” of toughened regulation of banks may be coming true.

Tighter regulations on the traditional banks could lend a hand to the shadow banking system and 2015 may be the year the sector enjoys record growth.

Seven per cent growth throughout 2013 means assets at non-bank lenders are topping $75 trillion, according to a recent study from the Financial Stability Board (FSB).

And as more new banking regulations come on stream in the next two to three years, we could be about to see more capital flow into the shadow sector, which could mean heightened systemic risk.

The FSB report shows shadow banking assets represent about 25 per cent of total financial assets, or half of banking system assets. But this is a “conservative” estimate, the board said, with the hedge funds sub-sector in particular “significantly underestimated”. This is because offshore financial centres, where most hedge funds are domiciled, are currently not within the scope of the study.

With this rise in shadow banking comes increased risk. In many ways the regulators could be creating an ever riskier system than before.

Non-bank lending channels can “become a source of systemic risk, especially when they are structured to perform bank-like functions (e.g. maturity and liquidity transformation, and leverage) and when their interconnectedness with the regular banking system is strong”, says the FSB.

Connectivity makes the risks ever greater, the board adds, as stress in one sector can be “transmitted to the other, and can be amplified back through feedback loops”.

Indeed the Global Financial Stability Report, produced by the IMF, estimates that shadow banking accounts for at least one-third of systemic risk in the US, a level that has been on the rise since the financial crisis.

The US, UK and China have the largest exposure. Australia and Chile saw the biggest decreases in the exposure of their banking system to non-bank financial entities during 2013. On the other hand, credit risk for banks increased most notably in the Netherlands, and Spain.