Strengthening Oversight and Regulation of Shadow Banking

1 Overarching remarks

The Financial Stability Board (FSB) mentions key issues of shadow banking such as excessive maturity liquidity transformation, immense leverage, procyclicality, highly complex and deeply intertwined credit intermediation chains as well as regulatory arbitrage. The FSB also provides a complex framework of meaningful measures. In order to make these measures effectively implementable, the following points are of relevance for all three consultative documents.

1.1 Appropriate policies: more courage instead of less

The FSB intends to design an approach which is proportionate to financial stability risks. However, quantitative specifications of the proposals are still missing. Even in the regular sector, standards are often far too low. A recent example is the renewed weakening of Basel III rules in terms of liquidity standards (Master). In order to be effective, the proposed measures must be substantial enough. Hence taking care in weighing the pros and cons of a policy means in particular not to overestimate any alleged cons, not to underestimate the pros, and especially not to underestimate the opportunity costs of remaining too weak.

That applies, for example, to the:

• size and composition of capital and liquidity buffers (to be suitable for every-day fluctuations as well as against stress scenarios of runs)
• limits on leverage
• weighted average remaining maturity for assets and liabilities (to avoid maturity mismatch between assets and liabilities)
• standards to calculate collateral haircuts
• collateral reinvestment guidelines.
  

Money market funds should indeed use the market value of their assets for pricing their shares, in lieu of rounding up the prices by an amortised cost accounting convention. This proposal of the FSB has also been strongly supported by Caliari: A fixed per share pledge fosters an expectation of safety and creates a “fictitious liquidity”. That is inconsistent with the fact that money market funds face credit, interest rate and liquidity risks as well. Regulators should withstand the argument of certain lobbyists, that this might reduce the attractiveness of the vehicle. As Caliari succinctly puts it: “This might well be the consequence if the vehicle's only benefit was its capacity to hide true risks. But, then, would their disappearance of shrinking size be such a bad thing?” (Caliari, p. 5) It is important not to weaken the fair value pricing requirement through exemptions. Unfortunately, the FSB has already opened the door to probably unnecessary exemptions by mentioning that amortised cost method can still to be used in limited circumstances (consultative document 1, p. 7).

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