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"Shadow" banks, such as hedge funds or trading houses, benefit the real economy by lending to risky ventures that regular banks avoid. But if their loans turn bad, they may collapse, taking regular banks with them, because they lack a capital cushion. Better prudential oversight is needed to reduce shadow banking's systemic risks, without stifling its benefits to the economy, say MEPs in a resolution voted on Tuesday.
Shadow banking institutions account for up to 30 per cent of the global financial system, worth over €50 trillion in 2011. In good times, they provide credit to people or entities that otherwise cannot get it and so fund the real economy. But if they make bad investments they have no protection, because they do not hold deposits and have no access to central bank liquidity.
Risks to regular banks
Shadow banks do not exist on their own. They are interconnected with regular banks, which often use them to get round capital and accounting rules. If they collapse, they can cause a domino effect across other financial institutions and borders, bringing down regular banks and ultimately harming taxpayers across the EU who are obliged to come to the rescue.
Safeguard alternative funding
MEPs say that shadow banking should be better monitored and supervised, so as to reduce the systemic risks they pose without cutting of the benefits that they provided to the real economy.
Prudential oversight should reduce the systemic risks that shadow banking may pose due to the lack of data on financial flows and interconnections and the highly complex nature of its financial products. At the same time, shadow banking's beneficial effects on the real economy, such as providing market players with alternative funding and liquidity should be identified and preserved.
Identify systemic risks
MEPs also suggest ways to reduce identified systemic risks, such as extending capital requirements to all unregulated entities, imposing limits on the complexity of financial products or considering whether shadow banking entities linked to a bank should be included in the bank's balance sheet.
Finally, MEPs call on the Commission to adopt a consistent approach to collecting data centrally, with a view to mapping all financial service transactions in real time so as to capture the riskiest deals.