Canada’s shadow banking system needs more transparency, not re-regulation, says a study published Thursday by the C.D. Howe Institute.

The paper, written by Christian Calmès and Raymond Théoret, two professors at Université du Québec (Outaouais), notes that the financial crisis revealed the dangers to financial stability posed by the growth of the so-called shadow banking system.

Shadow banking has moved the concept of banking away from the basic business of taking deposits and lending, towards more market-oriented banking activities, particularly securitization.

“However, shadow banking is opaque; a problem that was underlined in the recent financial crisis,” the report says.

The answer to this problem, the report says, is not more regulation, but more transparency.

“Market-oriented operations should be more exposed to daylight, to enable a better evaluation of true bank risk, and regulatory agencies should require detailed reports on activities generating non-interest income. Better indicators of leverage need also to be developed, owing to leverage’s role as the principal channel of bank risk-taking,” the report says.

Re-regulation would present a complex problem, the report warns, and could lead to an increase in the risk taken by banks.

“In particular, if regulation became more stringent, it would likely increase banks’ regulatory capital arbitrage. Indeed, it would induce banks to expand in less regulated activities, such as hedge fund activities, which are riskier than traditional business lines,” the report argues.

IE