14 March 2012

FSA Lord Turner: Shadow banking and financial instability

In his speech, the Chairman of the Financial Services Authority (FSA), Lord Turner, set out how the 'shadow banking' sector contributed to the financial crisis, the risks it still poses to financial stability, and the importance of a sufficiently comprehensive and radical policy response.

"In autumn 2008 the developed world’s banking system suffered a severe crisis. In response, the world’s regulators and central banks have focused on building a more stable banking system for the future: less leveraged, more liquid, better supervised and with even the largest banks able to be resolved without taxpayer’s support. The implementation of that bank-focused regulatory agenda is still unfinished, but much progress has been made.

So there is need to ensure that the regulatory response appropriately covers shadow banking as well as banks. The Financial Stability Board has therefore committed to the G20 that by the end of this year we will produce both a comprehensive analysis of the risks created by shadow banking and a package of proposed regulatory responses. Last year, FSA published documents defining shadow banking, attempting to measure its size and setting out an array of possible policy responses.

But the task is challenging. And the difficulty starts with definition – what exactly is shadow banking and how exactly did it contribute to financial instability?"

Lord Turner reviews in his speech what we know about shadow banking, how we best define it, and he considers the range of possible policy responses. He reaches three main conclusions:

• First, that there is need to understand shadow banking not as something parallel to and separate from the core banking system, but deeply intertwined with it.
• Second, that the way in which shadow banking contributed to financial instability reflected fundamental developments in our financial system which are as relevant to banks as to shadow banks, which remain important today, and which could produce new problems in the future.
• Third, that as a result we should not take the decline in some specific indicators of shadow activity which has occurred since 2008 as suggesting that the risks have gone away.

Full speech

© FSA - Financial Services Authority