Finance
2016-04-19
Introduction
This paper is devoted to the possible spillover effects between the usual banking and existing shadow banking systems and the impact of regulatory policies on the shadow banking system. The usual banking system consists of the banks and regulatory agencies. In comparison, the shadow banking system is a set of financial institutions, which are not banks, but perform their functions. The issue of the shadow banking system has become more important after recent global financial crisis. The Financial Stability Board has been established at that time. According to experts of this organization, various aspects of the shadow banking system are the causes of instability in global financial markets. The main function of the shadow banking sector is the credit intermediation and it can undermine the stability of the whole financial sector (Adrian, 2009). According to estimates of different specialists, the shadow banking system has already reached $ 71 trillion (in the end of 2012). As specialist Gorton (2010) noted, the shadow banking system is the outcome of the fundamental changes in the entire financial system during last thirty-forty years.
The representatives of the shadow banking system are traditionally considered hedge funds, private equity funds (private equity), unit investment banks, money market funds, primary market dealers of government bonds, brokerage firms and a number of other financial institutions. The usual banking system does not have above mentioned organizations in its structure. It should be noted, that current governments of the developed countries consider limiting the impact of the shadow banking system to the whole one. It can lead to spillover effects, which are analyzed below.
Background and Related Work
One can say that current regulatory activities are not efficient given that the shadow banking system grows in the US and the whole world. Many papers of such specialists as Adrian, Gorton, Hanson and others are devoted to this issue. There are at least four aspects of the credit intermediation of non-banking institutions, which can destabilize financial sector:
repayment period transformation: receiving of short-term funds to invest in longer-term assets;
liquidity transformation: this concept is similar to the transformation of repayment period and it envisages the use of liabilities, which are similar to cash, in order to buy complexly marketable assets (for example, loans);
possibility to create and provide leverage: it assumes the use of techniques such as borrowing for the purchase of fixed assets in order to increase the potential profit (or loss) on investments;
credit risk transfer: the transfer of the risk of the borrower defaulting from the initial creditor to third party.
In this case, analysts of the Financial Stability Board claim that the changes are necessary in the conduct of repo transactions and securities lending practice. Thus, repos and securitization must be regulated, because they are new forms of banking with the high level of vulnerability. In addition, regulators consider that multiple loans under collateral securities may become associated causes of credit bubbles and lead to increased financial instability. It concerns such cases, when investors apply for the same asset, which was used as a means of securing a loan. According to the proposals of regulators, it is planned to limit the amount of credit funds that may be issued under the ensuring an asset.
For example, according to the current options FSB proposals, corporate bonds with a maturity of less than one year will lose a minimum of 0.5% of its value as a security asset. In other words, securities worth $ 100 can be brought to obtain credit funds in the amount of $ 99.50.
The securities and securitized assets, consisting of bond with maturities of five years or more, will lose 4%. Such activities aim to limit the functioning of the shadow banking institutions. At the same time, a number of financial market participants have noted that the introduction of more stringent control over the repo market and securities lending will require major changes in the financial and regulatory systems of many countries. The last ones do not ready for it and it can negatively impact on their whole financial system.
Above mentioned activities can be considered as the first step towards the transformation of the shadow banking system to the stable functioning market mechanism. It will help to diversify the sources of funding for the global economy and reduce the risks of financial instability.
It should be noted that the regulation of the shadow banking system needs to apply the so-called “macroprudential” approach that recognize the importance of equilibrium effects and seeks to protect the whole financial system (Hanson, Anil and Stein, 2010). The main tools of macroprudential policy include the following: directed lending of the state by domestic investors (such as pension funds or banks); regulating and limitation of interest rates; regulation of cross-border capital movement; state debt management; the establishment of the taxes on the transactions with securities.
It is important to note that macroprudential regulation is particularly effective to control the state debt. Nowadays, the state debt in many advanced economies is at its highest level and it is more than the gross domestic product in some countries. Some governments are faced with the need to restructure the debt. Therefore, the main task of macroprudential regulation of many developed countries is to reduce the state debt.
Macroprudential policy, as opposed to microprudential standards, has two essential characteristics. Firstly, macroprudential regulation requires higher standards for institutions, markets and instruments that are systemically important. Thus, additional requirements allow systemically important institutions to use a buffer of capital and liquidity in cases of financial instability. Secondly, prudential standards should be countercyclical to confront imbalances in the financial markets. This is due to the fact that the majority of risk assessment models is based on historical data, which tend to improve during periods of economic and financial boom, and remains undervalued during the rise of the credit market. Thus, the dynamic prudential regulations are designed to smooth out the effect of pro-cyclical risk assessment. The great example of effective banking regulating can be the Canadian system. The last one differs by the strong level of centralization and state regulating of all financial institutions. Limited competition of banks, of course, increases the cost of financing for Canadian businesses, but at the same time it creates a stable financial environment.
Methods
It needs to use general scientific and special methods in order to conduct this investigation. A group of general scientific methods includes analysis, synthesis and summarization techniques. Such method as modeling is actively used in the investigation to present different types of the banking systems. The second group includes comparison, historical retrospective.
Results
After analyzing the features of the usual and shadow banking systems, one can say that an existing system is more risky, but at the same time, it provides more opportunities to the small and middle-size companies, which are more interested in the loans and have limited opportunities for financing. The transition to the “more usual banking system” can reduce the competition level among companies as well as among the banks. It is the main spillover effect between usual and shadow banking systems.
A lot of specialists state that macroprudential approach is the most suitable in order to limit the influence of the shadow banking system. At the same time, macroprudential approach is not flexible and it cannot take into account all features of the international market. Such policy can limit the growth of the domestic market or even contribute its stagnation process. Regulation and limitation of the shadow banking system can lead to the acquisition of the companies in the different business areas. The representatives of the small and middle business will be threatened, because they are more risky and cannot compete on the market due to fewer opportunities for loans and usage of the foreign capital.
Conclusions
In conclusion one can say that the shadow banking system includes the banks and other financial institutions, which perform similar functions. The spillover effects between the usual banking and existing shadow banking systems are analyzed in the paper. It should be noted that shadow banking system is characterized by higher risk than usual one. It leads to greater competition in the market and the emergence of new financial instruments, which contribute to the economic development. In this case, regulators of the banking industry in the world should find balance between stability and risk in the future.
References
Adrian T. (2009). Shadow Banking System: Implications for Financial Regulation. DIANE Publishing.
Gorton G., et al. (2010). “Regulating the shadow banking system [with comments and discussion].” Brookings Papers on Economic Activity, 261-312.
Hanson S.G., Anil K.K. and Stein J.C. (2010). A “microprudential” approach to financial regulation.” Chicago Booth Research Paper. 10-29.
