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Shadow banking in the spotlight

‘Regulation not the silver bullet.’

JOHANNESBURG – As long as there are not sufficient and viable alternatives to some of the questionable activities that take place within shadow banking it will continue to flourish, an analyst says.

Shadow banking is a fairly wide-ranging concept that includes any form of non-bank credit intermediation. It typically involves short-term funding or borrowing to enable longer-term lending or investment in less liquid assets.

Concerns associated with shadow banking have increasingly come under the spotlight after the global financial crisis when it became apparent that it was a source of some of the systemic instability and the risk experienced in the global financial system. Because these institutions operate at least in part in an unregulated part of the system, they generally don’t have the same safety net as those that operate in the highly regulated banking environment.

In the South African context money market funds, which have got very little regulation associated with it, are one component of the shadow banking system. This was highlighted during the African Bank Investments (Abil) fallout last year when some money market funds with exposure to the bank’s bonds took a 10% “haircut”.

Other examples are alternative lending channels, which include a variety of non-bank loan companies, microfinance companies specialising in credit provision to small enterprises, peer-to-peer lending channels and forms of retail-oriented loan provision.

Speaking about themes emanating from the 2015 Shadow Banking Report published by the CFA Institute, Nerina Visser, board member of CFA South Africa, argued that regulation on its own would not solve the problems associated with shadow banking.

In fact, increased regulation often introduced unintended consequences. It was also important to provide viable alternatives, she said.

“I think that is an aspect within South Africa that we have not dealt with sufficiently.”

This includes the provision of banking products to the unbanked as well as investment opportunities to those with limited knowledge and means and to ensure access to capital.

“Many of your bad and ugly shadow banking practices will be able to continue to flourish as long as we don’t put an alternative in place and we don’t have the necessary awareness,” she said.

South Africa can either become a nanny state and overregulate or acknowledge the cause of the problem and provide alternatives to address it instead of focusing on the symptoms, she said.

But although shadow banking is blamed for many of the ills that have transpired during the global financial crisis, it is not all bad, Visser said.

She said some parts of shadow banking provide a significant and valuable source of non-bank finance that can support real economic activity.

Ultimately it is about measuring the risk appropriately and making sure that risk management practices are in place.

The challenge is the lack of transparency, which makes it difficult to assess the risk appropriately, she said.

Visser argued that there are risks to the financial system if shadow banking is not adequately supervised.

Regulators around the world still grapple with the difference between supervision and regulation – understanding the need for rules and enforcement in some instances and the need for observing and guiding in other cases, she said.

In the South African context there is significant pressure to reduce fees in the financial services industry, but at the same time there is a rising regulatory burden, which increases the cost of compliance.

Visser said this not only puts pressure on participants but also squeezes small players out of the industry because having economies of scale is the only way to be cost effective and comply with regulation.

“We are fast moving towards a space where we are going to have ‘too big to fail’ investment managers or fund managers or asset managers or financial services providers.

“Does that assist in the stability of a financial system? Not at all – it makes it more risky and especially if you also want to encourage smaller players to come into this market,” she said.

She argued that stakeholders should think differently in terms of how they deal with the requirement for regulation, compliance and transparency.

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