WASHINGTON: Lightly regulated “shadow banking” has grown to huge proportions in the global financial system and increasingly poses a risk to stability, especially in the United States, the IMF said on Wednesday (Oct 1).
More than US$70 trillion in assets are handled by shadow banks around the world, Gaston Gelos, chief of the Global Financial Analysis Division at the IMF, told journalists in a briefing. “It’s quite large,” he said. “It’s very important to understand what’s going on there to be able to assess risks.”
The sector includes lightly policed institutions like mutual funds, money market funds, wealth management funds in China, and finance companies in emerging economies, that take money from investors and lend it like banks.
They have grown larger in the extremely low interest-rate environment of the past six years, as investors seek higher yields on their money and banks tighten up under tougher post-crisis regulation.
But the International Monetary Fund says in a new report that the risks are high because shadow banking largely depends on short-term funding. In a scare, it says, the impact of panic withdrawals can snowball into the broader financial system and global economy with outsized impact.
That was seen in the financial crisis in 2008, when US money market funds which were important lenders in Europe faced large redemptions, and with the near-collapse of companies like insurer AIG. Since the crisis the power of shadow banks has only grown, the IMF report notes.
In the United States, shadow banks have nearly twice as much assets than banks, and in the eurozone their assets have reached 60 percent of the banks.
In developing countries the figure is close to 60 percent. The sector has rocketed in China, where banks face interest rate controls, pushing savers to seek better returns on their money outside the banks. The IMF estimates shadow banking amounts to 35-50 percent of China’s gross domestic product, and said the sector “warrants close monitoring.”
“Shadow banking tends to take off when strict banking regulations are in place, which leads to circumvention of regulations,” said Gelos. “It also grows when real interest rates and yield spreads are low and investors are searching for higher returns.”
The report said shadow banking serves a good purpose, broadening access to credit, especially in emerging-market economies. But it said authorities need to have more information on the sector to gauge the level of systemic risk, and to regulate where possible.
Financial system regulators “should be on the lookout for activities or entities that can pose a risk to the system … How to tackle them will really depend on the nature of the activity,” Gelos said. “This needs to be continually reassessed because this is a very dynamic sector.”