Are regulators on top of shadow banks? - Editor's Blog -

Where shadow banking is driving credit creation, regulators are liable to find their efforts to calm things down meeting with political resistance. India and China are both in focus, writes Brian Caplen.

With banking ever more highly regulated, it is obvious that credit creation on a grand scale is going to take place outside of the sector. As a result shadow banking (the broadest of terms that includes insurance companies and pension funds as well as collective investment vehicles and finance companies) now accounts for financial assets of $160trn or 48% of the global total.

Within this figure the assets of most concern are the $45.2trn (13% of the total) where there is credit intermediation and associated financial stability risks. With shadow banking being done on this kind of scale, it is easy to understand the potential for things to go wrong.

Regulators are already alert to the risks of shadow banking through the efforts of the Financial Stability Board, which will release its latest global shadow banking monitoring report in a few weeks. The figures above came from last year’s report.

But being aware of a problem is different from being able to do anything about it. A number of regulators were aware of mispriced risk ahead of the financial crisis but clamping down would have hurt banking profits and tax revenues and would not have been well received by finance ministries.

This problem has raised its head in India, where with state-run banks preoccupied in sorting out their balance sheets and constrained in lending, an opportunity has opened up for shadow banks to move into consumer lending and house finance. Analysts estimate that shadow banks accounted for one-third of all new loans in India over the past three years and their total assets amount to 14% of GDP.

A warning sign came in 2018 when difficulties with a shadow bank led to a clash between the central bank, the Reserve Bank of India, and the government over attempts by the former to cool things down. With shadow banking amounting for such a large share of credit in India, any controls on the sector would hit growth ahead of an election.

The next test is going to be in China, with efforts to curb shadow banking coinciding with an overall growth slowdown. In a recent Moody’s report, analyst George Xu notes: "The mounting pressure on growth has prompted the authorities to adjust the pace not only of deleveraging but also the crackdown on shadow banking.”

Keeping economic growth moving is a laudable aim but protecting the health of the financial system must remain a priority as disruptions there are likely to be even more costly to the economy in the longer term.

Brian Caplen is the editor of The Banker. Follow him on Twitter @BrianCaplen

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