European Commission Published a Consultation Paper on Shadow Banking

The European Commission (EC)  Published a Consultation Paper on Shadow Banking that is the first step in its plan for regulating this part of business of Banking sector. The Paper marks the start of a long awaited process targeted at an Industry worth an estimated 46 trillion Euro.

In Introduction of this Paper, EC expressed that the 2008 crisis was global and financial services were at its heart, revealing inadequacies including regulatory gaps, ineffective supervision, opaque markets and overly-complex products. The response has been international and coordinated through the G20 and the Financial Stability Board (FSB).

The European Union has shown global leadership in implementing its G20 commitments. In line with EU's Roadmap for Financial Reform, the Union is very advanced in implementing the reforms linked to the G20 commitments. Most of the reforms are now going through the legislative process. In particular, a major achievement has been the recent adoption by the Council and the Parliament of landmark legislation on over-the-counter derivatives.

Negotiations are also well developed on measures to revamp capital requirements for the banking sector. Overall, the reforms will equip the EU with the tools designed to ensure that the financial system, its institutions and markets are properly supervised. More stable and responsible financial markets are a pre-condition for growth and for the creation of a business environment that allows companies to thrive, innovate and expand their activities. This in turn enhances the confidence and trust of citizens.

However, there is an increasing area of non-bank credit activity, or shadow banking, which has not been the prime focus of prudential regulation and supervision. Shadow banking performs important functions in the financial system. For example, it creates additional sources of funding and offers investors alternatives to bank deposits. But it can also pose potential threats to long-term financial stability.

In response to the invitations by G20 in Seoul in 2010 and in Cannes in 2011, the FSB is therefore in the process of developing recommendations on the oversight and regulation of this activity.

The FSB's work has highlighted that the disorderly failure of shadow bank entities can carry systemic risk, both directly and through their interconnectedness with the regular banking system. The FSB has also suggested that as long as such activities and entities remain subject to a lower level of regulation and supervision than the rest of the financial sector, reinforced banking regulation could drive a substantial part of banking activities beyond the boundaries of traditional banking and towards shadow banking.

Against this background, the Commission considers it a priority to examine in detail the issues posed by shadow banking activities and entities. The objective is actively to respond and further contribute to the global debate; continue to increase the resilience of the Union’s financial system; and, ensure all financial activities are contributing to the economic growth.

The purpose of this Green Paper is therefore to take stock of current development, and to present on-going reflections on the subject to allow for a wide-ranging consultation of stakeholders.