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The Financial Stability Board is … is a thing, first of all, did you know that? It’s not the Financial Stability Oversight Council, though it is as far as I can tell a global version of that with similar composition (senior regulators! in a room!) and obsessions (shadow banking! money market funds!). It’s also not the Systemic Risk Council, which is different, insofar as it’s just a thing that Sheila Bair made up. I am going to make up a thing – the “Systemic Stability Oversight Board” seems available – and if you ask me nicely I will invite you to join it and we will make beautiful, beautiful reports together.
Like the FSB did with their report about shadow banking1 released yesterday. “Shadow banking,” like “junk bonds,” is a term that sort of assumes the panic it sets out to create, and so the report dutifully provides a number that is bigger than another number:
The shadow banking industry has grown to about $67 trillion, $6 trillion bigger than previously thought, leading global regulators to seek more oversight of financial transactions that fall outside traditional oversight. … The FSB, a global financial policy group comprised of regulators and central bankers, found that shadow banking grew by $41 trillion between 2002 and 2011.
Here is that in graphical form:
Holy crap look at that purplish line go! Oh wait that purplish line is just regular banks; shadow banks are the red line. Which also goes up. Just not as fast. If it worries you that shadow banks added $41 trillion in assets in 2002-2011, you might spare a thought for non-shadow banks adding, what, $80 trillion in assets? I submit to you that non-shadow banks have shadowy places of their own; I half-seriously submit to you that the term “shadow banking” functions to make regular banking sound less shadowy, like Disneyland in Baudrillard.2 Here it is in percentage terms:
This is sort of the story of shadow banking being a more or less steady part of the (rapidly growing!) financial system over the last decade, while banks and central banks got more important and pension funds and public finance got less important. That is a story with some intuitive oomph to it; your pension is gone but JPMorgan, and the Fed’s balance sheet, are bigger than ever.
Oh but also! There are other parts of the story. Those parts too are told in charts. Here’s an important one, breaking down those “other financial institutions” that are shadow banks:
The report explains that “other investment funds” means (1) mutual funds other than money market funds (so, like, your S&P 500 index fund) plus (2) ETFs (so, like, your S&P 500 ETF). One thing to consider here is that systemically scaaaaaaary shadow banks – money market funds, non-bank broker-dealers, structured finance – are only about a quarter of the shadow banking industry as defined by the FSB. Though you’d be within your rights, and the FSB are within their rights, to find aspects of your S&P 500 mutual fund, like its securities lending business for instance, systemically scaaaaary too.3
I do not know what to tell you about Saudi Arabia! But I suppose I could plausibly tell you that (1) Germans finance their things through banks and (2) Americans finance their things through the stock market and their stock market through mutual funds, and I feel like you’d say “yeah, okay, that sounds right.”
So some of this is less ooooooh shadow banking and more bank versus market financing. But I guess that’s the same thing? Here’s how the FSB defines shadow banking:
The “shadow banking system” can broadly be described as “credit intermediation involving entities and activities (fully or partially) outside the regular banking system” or non-bank credit intermediation in short.
So, that’s among other things just companies issuing bonds?
Anyway the FSB has some recommendations and they include things like “find out more about shadow banks,” “have more regulated and less procyclical repo haircuts,” and “stop letting firms rehypothecated client securities for prop trades.” Those things are nice!4 The repo stuff is particularly thoughtful; I enjoyed the recommendation that the repo haircut for >5-year corporate debt be 8%5, which is the same as the total capital requirement for banks under Basel III. If you think of banks, archaically, as being in the business of taking deposits to provide medium-term financing to actual companies, then you might like the rough equality there: the folks in Switzerland have decided that banks, shadow or otherwise, should be able to borrow 92 cents of every dollar that they lend to corporate firms, and apply that rule roughly consistently across different degrees of shading. That’s … consistent, though I suppose also consistency of arbitrary numbers is not entirely a virtue.
But, yeah, it’s good and full of “tough new rules” and it makes sense and I will sleep better at night knowing some regulators in a room are on this shadow banking thing but, also. “Shadow banking” is by definition – see above! – not a list of things, but rather a conceptual description of things united only by the fact that they’re not on a list. The list is “regulated banks”; you can make a new list of shadow banks, then regulate that list, but then somebody could find something not on your new list and off they’d go. “Regulate the class of things not previously regulated, in order to prevent dangers from lurking in the unregulated sector” is a dicey proposition, since you can’t regulate all the things that there might be. (Can you?) You make Extensively Studied Shadow Bank Subset A safer, and the bad things change their lurking location to Previously Unknown Shadow Bank Subset B.
Or something else. That first chart is sort of cheery actually. Regular banking has been regulated for ages and has only gotten more regulated since 2002. And in that time it’s grown by $80 trillion, double the (dollar not CAGR) growth of shadow banking. Perhaps the regulated places are the places to be.
Shadow Banking Grows to $67 Trillion Industry, Regulators Say [Bloomberg]
FSB seeks to tame shadow banking [FT]
FSB Press Release, Overview of Recommendations, Shadow Banking Entities, Securities Lending and Repos, Global Monitoring Report [FSB]
1. Reports! There is this one on the state of shadow banking, this one on what to do about it broadly, this one on oversight of shadow banking entities, and this one on securities lending and repos. Plus a press release.
2. “Disneyland exists in order to hide that it is the ‘real’ country, all of ‘real’ America that is Disneyland …. Disneyland is presented as imaginary in order to make us believe that the rest is real, whereas all of Los Angeles and the America that surrounds it are no longer real, but belong to the hyperreal order and to the order of simulation.”
3. The FSB gets less data-y on how much of this there is and its growth or lack thereof, perhaps in part because data is less good here. The FSB wants to fix that with better reporting of repo and securities lending.
4. Right? Why not? I don’t know, I have some residual feeling that rehypothecating client securities to support your own trades is like a human right, or at least a neat trick, but I can’t articulate why.
5. Page 14 here. That oversimplifies a more nuanced discussion on how to (1) make market participants actually think about appropriate repo haircuts rather than just relying on a blunt regulatory chart and (2) stop repo haircuts from being procyclical, as they rather notoriously have been. It’s worth reading.