Along with many analysts, bankers have been calling on global regulators to do something about “shadow” banks – that is, institutions that look like banks but don’t come under all the rules that increasingly define banking. Earlier this month, the Financial Stability Board (FSB) heeded the call and put out a background note on what to do with the shadow entities. Guess what, bankers? The answer lies in regulating banks even more tightly. The premise seems to be that, the more tightly the noose chokes big banks, the better off global finance will prove. Strangulation assuages those seeking vengeance, but it will, we fear, prove punitive for financial markets and the economies on which they depend.
For a detailed discussion of the FSB’s paper, we refer clients to the analysis of it sent out earlier this week. The FedFin report describes the preliminary nature of FSB consideration of this vital issue – after all, how good will all the Basel rules and other panacea for global finance prove if risky activities just squirt out of regulated institutions into shadow firms? We’ll give the FSB an “A” for at least an initial effort, but we can’t grade the FSB’s substance anywhere near as generously.
The reason for our dismay is that FSB in fact doesn’t do much about shadow banking in its note except first to define it – sort of – and then to posit that the best remedy for shadow banking is to regulate regulated banks still more. Determining that the most immediate shadow challenge is in “credit intermediation” – banking in all but name – the FSB then discusses where it can be found and how it might be done. To know more, it wants lots of monitoring – regulators seem to love nothing more these days than more data. But, rightly recognizing that more data are, at best, imperfect, the global body does propose a few more concrete steps to shed light on the shadows: regulate the way banks can do business with nonbank credit intermediators and quash anything in a bank that isn’t strictly banking. This comes, of course, in concert with all the other rules in place and under way to govern all of the risks of non-traditional activities. At this point, anything other than offering deposit products and making traditional loans is being pummeled with new rules. Come to think of it, even these two basic-banking businesses are getting the once over (see, for example, the FDIC’s new rules on deposit-insurance premiums and all the new capital standards for straightforward loans). These standards are nothing, though, in comparison with the others for “high-risk” activities (some of them the shadow ones on which the FSB focuses). Think, for example, of all the stringent new capital charges for non-traditional exposures (e.g., in the market-risk rules), the stringent inter-affiliate transaction limits in Dodd-Frank and all the wallops at “interconnectedness” in the works for systemic institutions.
The FSB paper apparently concludes that none of this is good enough. It’s not enough to govern bank dealings with nonbank financial institutions; the FSB wants to choke them. The thinking appears to be that, if banking can’t support it, shadow credit intermediation will have to cease. This is, at best, a speculative proposition. We know that all these rules will kill activities in banks. But, if they don’t throttle it everywhere else – unlikely in our estimation – the urge to regulate banks to the nth degree will, in the end, make global finance all the riskier