Liquidity and leverage are thus the defining features of banking, both ordinary and shadow, and the source of its vulnerability. The relevant comparison is thus between the residual costs of the regulated relationship and the effects of an anti-competitive industry structure.
In the years leading up to the crisis, the top four U. In place of the equity capital requirements generally applicable to banking organizations, G-M propose that NFBs would issue capital notes that are debt-like except in periods of stress, when they would convert to equity.
As excesses associated with the U. First, because systemic risk cannot be measured precisely, such insurance could not be priced accurately. A variant on this initial question is how much the legal environment for securitization should be changed in order to provide a source of stable short-term liquidity in wholesale funding markets.
Follow Kevin Wilson and get email alerts Your feedback matters to us! Its growth was checked by the crisis and for a short while it declined in size, both in the US and in the rest of the world.
The shadow banking sector operates across the American, European, and Chinese financial sectors,  Boesler  and in perceived tax havens worldwide. Where competition from unregulated entities is permitted, explicitly or de facto, capital and other requirements imposed on regulated firms may shrink margins enough to make them unattractive to investors.
First, it is difficult to How should we regulate shadow banking the right level of leverage for assets and institutions. Regardless of the eventual structure of the industry, NFBs essentially would be monolines, with highly correlated risk exposures.
Anybody else given broad regulatory authority — and someone needs to have it — would need to work hand-in-glove with the Fed in any event, especially when it comes to questions such as the Fed paying interest on reserves. Commercial mortgage-backed securities suffered from association and from a general decline in economic activity, and the entire complex nearly shut down in the fall of They do, however, underscore the degree to which the NFBs would require development of a new financial regulatory approach, as well as a restructuring of the ABS and repo markets.
It is the existence of conventional banks that Tamny thinks ought to be questioned! In truth, it may pose no greater challenge for the G-M proposal than for many existing capital rules. Here again though, the analogy is not a perfect one.
The severe problems now associated with ABS began with assets held by mismatched entities like structured investment vehicles or financial institutions engaged in capital arbitrage under Basel II, not those held by end investors.
Indeed, if this approach had promise, it might be feasible for a regulatory body to establish the requisite criteria without providing insurance.
We have to crack down on bank leverage? This financial engineering largely succeeded in insulating participants from idiosyncratic risk.
The first two questions I would pose about this creative policy proposal are the most basic: That said, it is pointless to give the central bank control of both levers if it is unwilling to use them or chooses to push them in opposite directions.
Our conclusions are based on a macro perspective of the economics of banking. Gary Gorton and Andrew Metrick have, in setting forth this proposal, continued to shape our understanding of the role and risks of the shadow banking system, as well as to add a specific proposal to our menu of possible responses.
In this respect, the G-M proposal moves in the opposite direction from Basel III, which has followed markets in making common equity the centerpiece of capital evaluation and requirements. There is not time here to enumerate the potential difficulties with these ideas, but they are not hard to discern, even as stated in such skeletal form.
In addition, of course, the history of Fannie Mae and Freddie Mac is a cautionary tale of the potential for a government monopoly with a conservative mandate to expand its operation into much riskier activities.
To deal with the externalities of shadow banking, we advocate quantity regulation. Moreover, the concerns mentioned earlier with respect to government judgments on credit allocation would remain, even if they are provided another layer of insulation through the device of a government corporation.
This has left the Financial Stability Oversight Council with "no latitude to determine what constitutes systemic risk," so their purpose has been thwarted from the start.
Shadow banking contributes to systemic risk by promising immediate cash and, therefore, safety against long-term risky investments. In truth, it may pose no greater challenge for the G-M proposal than for many existing capital rules.
G-M propose giving NFBs access to the discount window to forestall liquidity problems and runs on the NFBs, presumably in the same way that deposit insurance stopped runs on traditional banks. Unlike the business environment for banks in the s, however, securitization and repo lending are national--if not international--activities, with little to suggest that any advantage would be derived from local knowledge.
It also seems likely that the kinds of quantitative liquidity requirements currently under development by the Basel Committee on Banking Supervision would be difficult for NFBs to satisfy.
GS are a direct risk to the financial system because of their huge size and enormous complexity, and because some of them suffered terrifying collapses in A cost-benefit discussion is probably needed at the outset, with careful specification of the benefits of the repo market that G-M are trying to save, weighed against the likely impact on--among other things--the securitization market and regulatory system.
In essence, all of an NFB's capital would be contingent capital.
Of course, more things have to be shown on the balance sheet now, according to The Economistbut new work-arounds will be found, as they always are.
G-M require that NFBs be stand-alone entities, and specifically prohibit ownership by commercial banks in an effort to avoid implicit contractual guarantees.We argue that shadow banking should be regulated indirectly, by capping the permissible leverage on the assets that can be pledged as collateral.
We argue that a dual form of regulation is necessary to constrain shadow banking effectively.
Sep 28, · PARIS, Sept 28 (Reuters) - Extending bank regulations to the so-called shadow banking sector is not only probably unfeasible but may fuel market swings, several central bankers said at a.
Regulating the Shadow Banking System We document how the rise of shadow banking was helped by regulatory and legal changes that gave advantages to three main institutions: money-market mutual.
How should we regulate shadow banking? Contents Introduction Page 1 I) The features of the shadow banking system and the reasons why it should be regulated Page 2 Features The role of shadow banking in the triggering of the crisis II) Proposed measures to regulate the shadow banking system Page 4.
Comments on "Regulating the Shadow Banking System" Governor Daniel K. Tarullo. as we have seen in the past, will be some combination of regulatory arbitrage, assumption of higher risk in permitted activities, and exit from the industry. For a survey of the entire shadow banking system, see Pozsar, Zoltan, Tobian Adrian, Adam Ashcraft.
Putting together these three definitions we can say that the shadow banking system is the network of financial intermediaries that conduct maturity, credit, and liquidity transformation without being subject to banking regulation and do not have formal access to central bank.Download