There is much talk in regulatory circles of “shadow banking“. It began after the credit crisis exploded, and has become a special interest of the Financial Stability Board, the global body set up to deal with future crises before they hit.
Policymakers fear that “shadow banks” will run similar systemic risks to those of badly-run real banks, but out of sight of banking regulators. The trouble is that it is as clear as mud what is, and is not, a “shadow bank”.
You don’t have to borrow from banks. Companies and governments have been borrowing for years by issuing bonds. That doesn’t turn the pension funds and insurance companies that buy them into banks, even if they are technically lending to the issuer. Nor does it mean that the investment managers who act on their behalf, or their funds, become “shadow banks”.
What worries me is how quickly the “shadow banking” conversation seems to turn to asset management products, particularly money market funds. These funds provide both a source of short-term finance for the banking system and a means for corporate treasurers to diversify counterparty risk. Policymakers cite them in the “shadow banking” debate because they are potentially subject to runs like banks and because they undertake “maturity transformation” – turning underlying assets with an average maturity of 21 days into instant access open-ended investments.
But if that is true for a money market fund, it is also true for a bond fund or an equity fund. By that logic, all funds are “shadow banks” and, by extension, should be regulated like banks. There are many reasons why this is wrong: the absence of leverage, the separation of the assets from the manager, and the liquidity of the underlying assets. And of course asset management products are already highly regulated.
The key point is this: if we are to develop a financial services market that is less addicted to banks, we need to make space for the distinctive role that asset managers can play and not regulate it away. They should not be drawn into regulatory responses designed for systemic firms.
We currently have before us proposals to increase asset management firms’ capital, to limit remuneration as stringently as at banks and to make them subject to resolution powers. Such measures are unnecessary for the asset management business model and risk driving them out of the market, simply entrenching the dominant role that the giant universal banks have in the financial system. Surely that is not what policymakers want.