European policymakers have published their plans for tightening the regulation of shadow banking, including proposed new rules on money market funds (MMFs).
The European Commission (EC) published what it’s calling its roadmap for tackling the risks inherent in shadow banking, which is not regulated to the same extent as banking, but involves many of the same sorts of financing activities as banks; and, is large enough to represent a systemic risk. It says that shadow banking, which includes hedge funds, money market funds, and other non-bank financial entities, is estimated as equivalent to 25% to 30% of the overall financial system.
“Risks must not be allowed to accumulate in the shadow banking sector, in part because new banking rules could be pushing certain banking activities towards this less highly regulated shadow banking sector,” it says.
To that end, it is proposing new rules for money market funds that aim to ensure that these vehicles can withstand redemption pressure in stressed market conditions by imposing new liquidity and capital requirements on them.
Additionally, it says that the transparency of the shadow banking sector must be improved so that the authorities can better monitor risks in the sector; that risks associated with securities financing transactions (such as securities lending and repo transactions) need to be addressed; and, that the high level of interconnectedness between the shadow banking system and the rest of the financial sector constitutes a major source of contagion risk.
“These risks could notably be addressed by tightening the prudential rules applied to banks in their operations with unregulated financial entities,” it said. Also, it’s planning to look at the supervisory arrangements for shadow banking entities/activities “in order to ensure that specific risks are adequately addressed.”
“We have regulated banks and markets comprehensively. We now need to address the risks posed by the shadow banking system,” said Michel Barnier, Internal Market and Services Commissioner. “It plays an important role in financing the real economy and we need to ensure that it is transparent and that the benefits achieved by strengthening certain financial entities and markets are not diminished by the risks moving to less highly regulated sectors.”