EIOPA's reply to the European Commission’s Green Paper on Shadow Banking

01 June 2012

EIOPA believes the Green Paper is a good starting point for preparation on how to apply the global recommendations by the Financial Stability Board in the European Union.

Definition of shadow banking (question a and b)

EIOPA agrees with the European Commission in using the FSB definition of the shadow banking system as a basis of the discussion. However, a definition which takes as a starting point all credit intermediation which involves entities and activities outside the regular banking system seems to be rather general.

In particular, EIOPA believes that it is important to further analyse the potential merit of including certain activities by insurance companies in a definition of shadow banking. In considering these activities, it is important to recognise that they typically constitute a small part of the activity of the insurance sector and do not constitute core insurance business. It is also important to distinguish insurers’ investment activities from credit intermediation. A central part of insurers’ core activity is investments in bonds (e.g. sovereign or corporate bonds), but also investing in other credit related assets. This activity does not constitute credit intermediation, even though it does expose insurers to credit risk. This is not shadow banking as understood by reference to the FSB definition.

Against this background, EIOPA has identified some activities for which it believes further consideration is required of whether they should fall within the shadow banking definition:

• First, there are certain insurance business lines that are directly related to the credit intermediation channel, namely credit insurance and surety business. While these constitute insurance business, they facilitate the operation of the credit channel.
• Second, insurance undertakings are engaged in a certain level of credit intermediation in the form of mortgage lending and, in some jurisdictions, direct lending to corporates, and this activity may be relatively widespread in some countries. There are also cases of limited indirect lending following as part of an overall investment strategy.
• Third, in some jurisdictions some life companies have, in the past, offered so-called “geared property funds”. Such funds involve the raising of “equity”, which is then combined with borrowing, often from a related bank, to invest in commercial property.
• Finally, some insurers engage in limited securities lending and repos. It is not unknown for this activity to include rehypothecation (i.e. reuse of collateral).

Against this background, EIOPA believes that it would be valuable to analyse how a definition of the shadow banking system could take into consideration the risk posed by the activities and not only the activities themselves.

Current measures already taken (question k)

As noted in the Green Paper, the EU has already adopted measures to regulate shadow banking entities and activities. For the insurance sector in particular, Solvency II addresses a number of concerns by providing consistent economic risk-based solvency requirements across EU/EEA for the first time.

However, it is worth considering if the different regulation in banking (CRD IV) and insurance (Solvency II) creates incentives for shadow banking activities in insurance or in conglomerates. In particular, the assessment of new regulations should take into consideration the possibility that they drive some entities or activities to the shadow banking sector.

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