IMF Survey : Shadow Banking Is Boon, Bane for Financial System

IMF News, October 1, 2014

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Canonical URL: IMF Survey : Shadow Banking Is Boon, Bane for Financial System

Publication date: October 1, 2014.
Shadow banking: entities that act like banks by taking money from investors and lending it to borrowers but are not governed by the same rules or supervised.
Examples of shadow banks: money market mutual funds, hedge funds, finance companies, and broker/dealers.
The IMF’s Global Financial Stability Report analyzes recent growth in shadow banking in advanced and emerging market economies and associated risks.

United States: shadow banking amounts to between 15 and 25 trillion dollars (depending on the measure).
Euro area: between 13.5 and 22.5 trillion.
Japan: between 2.5 and 6 trillion.
Emerging markets: around 7 trillion.
In emerging markets, shadow banking growth is outpacing that of the traditional banking system.
China: shadow banking size between 35 and 50 percent of GDP; growth over 20 percent per year.

Common drivers across countries:
- Strict banking regulations that encourage circumvention.
- Low real interest rates and low yield spreads prompting investor searches for higher returns.
- Large institutional demand for "safe assets," e.g., from insurance companies and pension funds.
Quote: “We found that the same factors often seem to drive the growth of shadow banking across countries,” — Gaston Gelos, chief of the Global Financial Analysis Division at the IMF.

Reliance on short-term funding can lead to forced asset sales and downward price spirals when investors seek rapid withdrawals.
United States: shadow banking accounts for at least a third of total systemic risk (measured as extreme losses to the financial system that occur with a very low probability), similar to that of banks.
Euro area and United Kingdom: contribution to systemic risk from shadow banking is much smaller relative to risks from their banking systems.
Since 2009, non-money market investment funds have grown fastest in advanced economies:
- United States: from 35 to 70 percent of GDP.
- Euro area: from 35 to 65 percent of GDP.
Trend toward funds holding higher proportions of less-liquid assets (for example, commercial loans), particularly in the euro area and observed similarly in the United States.
Liquidity mismatch risk: liquid claims to investors backed by less-liquid assets can lead to runs and fire sales if many investors redeem simultaneously.

Broadens access to credit, especially in emerging market economies with constrained traditional banking networks (capacity or regulatory constraints such as restrictions on lending or on interest rates).
In advanced markets, various types of funds have been providing long-term credit to the private sector as banks lend less.
Shadow banking can deepen market liquidity and improve risk sharing, increasing financial system efficiency.

Monitor shadow banking as part of policies to keep the overall financial system safe.
Degree of oversight and regulation should depend on how much shadow banking contributes to systemic risk, in line with Financial Stability Board recommendations.
Implement a macroprudential framework to detect shifts of shadow banking into less-regulated areas.
Joint action required: macroprudential and microprudential supervisors need to work together.
To assess risks properly, supervisory authorities and statistical agencies must provide much more detailed data on shadow banking.
International regulatory cooperation is crucial to prevent risk migration when regulatory initiatives are implemented by only a few countries or are poorly coordinated.
Regulatory tightening in one country may lead to migration of activities to others with laxer rules.
Governments have begun to put in place rules to address the risks through the work of the Financial Stability Board.

Source: IMF Survey, "Shadow Banking Is Boon, Bane for Financial System", October 1, 2014.