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The emerging clarity around regulatory policy is welcomed, as is the recognition by the FSB that shadow banking provides a real benefit to the economy: the FSB recommendations specifically acknowledge that, under certain conditions, non-bank credit intermediation can increase the resilience of the financial system.
The FSB will, in September 2013, outline the progress of each workstream and provide final recommendations. It will then work on procedures to ensure that the policy recommendations are implemented appropriately. There will, therefore, still be a significant period of time before the exact shape of the shadow banking sector is known.
What is clear, however, is that shadow banks will be subject to regulation and the composition and characteristics of the sector in the future are beginning to take form. The interconnectedness with the regular banking sector will be curtailed, the ability for banks to arbitrage their capital through shadow banking structures will be more limited and shadow banking entities will be subject to at least some bank-like regulation.
By limiting banks’ interaction with shadow banks and by closing off some existing shadow bank activity through regulation, further funding gaps will be created. This is in addition to the existing funding gaps resulting from recent changes in bank capital requirements and the general theme of de-risking in the banking sector. This presents opportunities to providers of alternative sources of finance, who may also find that they face less competition if some market players are forced to exit the market.
From the FSB’s perspective, the proposed policy of looking at economic function over legal forms is the correct approach – entities should be regulated according to what they do, and not by what they are called. The FSB, by setting international standards for the regulation of shadow banking, has the important task of ensuring that its policy recommendations strike a balance between preventing the build-up of systemic risk in the financial system and stifling activities that diversify risks and provide a much needed stimulus for growth in today's challenging economic environment.