Shadow Banking: recent articles and speeches

We’ve seen several recent news articles and commentary on Shadow Banking, from The Economist’s special report to news on China’s CITIC. Below are the most interesting articles we’ve seen lately.

The Economist’s review of Shadow Banking wasn’t amazing to us, but then again, it was pretty certainly meant for a more generalist audience. The most important part of this special report was the attention it paid to the topic; Shadow Banking is sure to be on the minds of the economics intelligentsia for the next few weeks. The articles did note an interesting conversation about lending activities happening between private firms, say hedge funds and other hedge funds. If one of them goes bust, there should be no systematic risk. This special report is worth a quick read on the train. A link is here.

The FT reports that China’s CITIC Group now has Shadow Banking exposure of US$52 billion, three times the amount is had just a few years ago. The driver here, as with the majority of China’s Shadow Banking activity, is Wealth Management Products (WMPs) set up for wealth management vehicles that pay higher interest rates than ordinary investments. As the FT notes, “Wealth management products (WMPs) and other non-standard credit instruments, which offer higher yields than traditional corporate bank deposits, are issued by property developers, coal miners or other third parties. Though often sold through state banks, which collect fees for acting as intermediaries, there is no guarantee that investors will get their money back if the third-party issuer encounters financial difficulties.” This market is estimated to be US$4.4 trillion, a figure that makes WMPs sound a lot like financial WMDs (Weapons of Mass Destruction). The FT article is here. On a related note, MNI News reported a sharp selloff in the Shanghai Stock Exchange as news spread that banks would need to stop their lucrative WMP businesses.

In the US, Comptroller of the Currency Thomas Curry has told state regulators to prioritize Shadow Banking oversight. This will be interesting – while some areas like mortgage servicing, cited as one example by Mr. Curry, are viable to oversee, others including transactions between two private entities that facilitate credit and maturity transformation are well off the radar screen of US state regulators. We’re not sure at all how states are going to meet Mr. Curry’s call to action. Mr. Curry is pretty serious about all this, saying that “the system will not work well without the kind of on-the-ground supervision and regulation that your departments can bring to bear on these nonbank entities. The shift of financial assets into the shadow banking system could carry with it the seeds for the next financial crisis if we do not act quickly and effectively. We can’t tolerate a situation where banking activities migrate to nonbank financial institutions in order to escape prudential supervision. Much of the burden for regulating the shadow system will fall upon the states.” If we were US state regulators we’d be wincing about now. A link to Mr. Curry’s speech is here.

And lastly, Shadow Banking continues to prove elusive in its measurement. Reuters published an article citing David Wright, Secretary General of IOSCO: “In general we don’t fully understand how the financial system functions and I don’t think you can unless you have the data you need. I think we have a long way to go to fully understand all the connectivities and subtleties of the financial system.” Well said. The Reuters article is here.

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