Financial Stability Risks Rise as Activities Shift to ‘Shadow’ Firms
By Donna Borak

Nearly four years since the passage of regulatory reform legislation, policymakers have largely failed to curb risks outside the banking system, increasing the chance for significant financial instability in the future, according to a new paper by Federal Financial Analytics. The paper says that regulation of the banking system and the so-called “shadow” banking arena is increasingly imbalanced, posing a threat to the economy as risky activities shift to mostly unregulated institutions. “The increasingly stringent rules applied almost exclusively to the very largest U.S. banks are combining with rapid market change to create a major risk to financial stability and even macroeconomic prosperity,” writes Karen Shaw Petrou in a 17-page paper that is being presented at the Federal Reserve Bank of Chicago’s annual banking and regulatory symposium. “This risk arises because like-kind activities are increasingly not regulated in like-kind fashion. Regulation largely follows form — that is, the charter a firm selects — not function — the services provided and the risks presented.”