Shadow banking, which encompasses financial activities that take place outside the regulated banking system, is “potentially very unstable,” and vulnerable to liquidity shocks, Turner said. The shadow banking industry in Europe is worth $22 trillion, and $25 trillion in the U.S., by some estimates, he said.
“Our regulatory response should therefore entail a bias to prudence,” Turner, 56, said in the speech at the Cass Business School yesterday. Supervisors shouldn’t allow “complex interconnectivity” and “high leverage to develop in unregulated institutions or markets.”
The Financial Stability Board, which brings together regulators, G-20 central bankers and finance ministry officials, said last year that shadow banks may create “an opportunity for regulatory arbitrage.” Shadow banking includes money-market funds, securitizations and off-balance-sheet investment vehicles.
Regulators will struggle to develop policy responses to deal with shadow banking because of its complexity, Turner said.
“Any system this complex will defy complete understanding: and any belief that we can precisely calibrate our response to it will therefore be a delusion,” he said.
Global regulators at the FSB are committed to proposing tougher rules for shadow banking by the end of the year, said Turner, who is also an FSB member.
The FSA may impose minimum collateral requirements in the market for repurchase agreements, considered part of the shadow banking industry, Turner said in November.
The European Commission, the executive arm of the European Union, may tighten rules governing so-called repos, which are contracts where one investor agrees to sell a security and then buy it back at a future date and a fixed price, according to a document obtained on March 6.
A bankruptcy examiner’s report found that Lehman Brothers’ Holdings Inc., the lender whose collapse in 2008 sparked a financial crisis, used so-called Repo 105 transactions to move as much as $50 billion off its balance sheet temporarily to show investors it wasn’t carrying too much debt.
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