The workshop brought together researchers from US, Canadian and British universities in an attempt to provide a more focused definition of the shadow banking sector, of its links to government treasuries, central banks and private financial and non-financial institutions in the US, Europe and China. The workshop also weighed in on critical questions about how to regulate shadow banking so as to minimize its systemic risk.
A consensus emerged among contributors that shadow banking is constituted by both financial sector actors and activities that do not benefit from a government safety net in case of failure. This point was reinforced by PIMCO’s Paul McCulley, who kicked off the conference with a video, address that stressed the importance of government support for the financial sector and the fact that contrary to conventional wisdom the Dodd-Frank legislation has actual teeth as far as the financial sector is concerned. In his speech, he quipped that without the visible hand of the government the invisible hand of the market will have difficulties in keeping the shadow banking sector away from systemic risk zones.
Daniela Gabor’s analysis of the repo market took McCulley’s point further and showed that in effect the sector’s reliance on government bonds as collateral in their repo market transactions has turned government treasuries into the central banks of the sector. Her paper concluded that “through repo transactions, collateral moves in networks connecting banks to other banks or non-bank financial institutions. These connections are both systemic and fragile. Repo connections are fragile because they are the cheapest source of funding for leveraged financial activity, but also because practices of risk management and re-use can amplify concerns about collateral quality and ignite liquidity spirals. They are systemic because repo markets are now the most significant source of market funding for banks and non-banks with large trading portfolios. A run on shadow banking occurs as a downsizing of collateral networks, with a smaller number of connections supported by the same collateral simultaneous with a narrower range of acceptable collateral. What counts as acceptable in a crisis of shadow banking fundamentally depends on the institutional structures in which the repo market is embedded.”
Ewald Engelen did an in-depth analysis of the history of the concept of shadow banking. His excursus brought to the fore systematic attempts made by leading central bankers and economists to neutralize over time the moralistic undertones of the term “shadow” and diffuse alternative terms that put conventional banking institutions on a par with regulated banks. Next, Sara Hsu’s investigation of the composition and workings of the Chinese shadow banking sector evinced the extremely idiosyncratic nature of this pillar of finance in the Chinese context. Then, she used a bank stress test to analyze solvency risk for the systemically important financial institutions and the banking system as a whole. The test found that there is some considerable risk of bankruptcy and potentially a risk of liquidity shortages in shadow banking institutions at this time.
In her presentation, Giulia Menillo analyzed the ways in which shadow banking is intertwined with credit rating agencies. Her findings indicate that these agencies shape the perception of credit risk of the sovereign bonds used as collateral in the repo market. Focusing on the Eurozone, the presentation indicated that bond investors’ and regulator’s reliance on sovereign rating agencies amplified the procyclical reaction of sovereign bond markets as a whole. Menillo concluded that “driven by the problematization of public finances and debt, sovereign rating events could stylize restrictive fiscal policies as an inevitable therapy, and decouple the consequences of the financial crisis from its actual origins in the financial sector”, therefore redefining the crisis of the Eurozone as strictly connected to the fiscal problems of sovereigns.
In his concluding remarks, Eric Helleiner brought to the fore a few of issues that future scholarship should focus on. He remarked that:
- After Lehman, there have been clear expectations that the shadow banking world would contract, endogenously and through regulatory action. But we have seen the opposite to be the case and we can expect this trend to continue. The government played an important role in this regard via joint private-public coordination in both the West (e.g. changes to bankruptcy law for US repo markets that offers safe harbour; governments supplying cheap collateral) and China (the government encouraging shadow banking as a form of a “shadow Keynesian stimulus”). There is a tendency for policymakers to increasingly normalize backstops to institutions and activities the FSB identifies as parts of the shadow banking sector. It is not clear, however, who gets what and what are the distributional consequences of this state-market coordination.
- There has been an initial focus on securitization rather than repos. It is surprising that it took so long for scholarly interest to expand to repos in both policy and international political economy.
- FSB consultations show a different reaction from developed and developing countries in terms of the understanding of what shadow banking is, and how it may be used to pursue certain agendas by the Global North. China is a good example here of asking whether the FSB definition should make explicit reference to systemic risk, and at what level. Moreover, more work is needed to explore the international relations dimension of shadow banking: Do US, European and Chinese interests conflict or overlap in this regard?
- It is not clear what are the implications of cleansing “shadow banking” into “market-based finance” in terms of politics of the term produces. Also, what resolution mechanisms are being discussed to manage future crises of shadow banking? Post crisis, a lot of work has been done on getting prepared for avoiding future bank bailouts, so why is the opposite happening with shadow banking? Why do we see a dearth of public controversies around systemic risk posed by some aspects of shadow banking?