Shadow banking vehicles or funds that are
sponsored or operated by banks should be consolidated on to bank balance sheet,
emphasized Paul Tucker, Deputy Governor of the Bank of England. In remarks at a
European Commission seminar, he also said that money market funds should be
required to choose between being Variable Net Asset Value (NAV) funds or
Constant NAV funds.
The definition of shadow banking employed by
the Financial Stability Board and the Commission is credit intermediation,
involving leverage and maturity transformation, that occurs outside or partly
outside the banking system. In addition to leverage and maturity transformation,
Mr. Tucker would include monetary services in that definition.
Shadow banking comes in many forms, he
noted. The liquidity offered by some shadow banks relies almost entirely and
openly on committed lines of credit from commercial banks. In these cases, the
liquidity insurance offered by the shadow bank is derivative.
But for other shadow banks, liquidity
services are offered without such back-up, making claims on the shadow bank
effectively a monetary asset. Examples of the latter would include money market
mutual funds and an element of the prime brokerage services offered by
securities dealers to leveraged funds
The deputy governor posits that shadow
banking vehicles sponsored or operated by banks are effectively part of their
parent bank, including structured investment vehicles, conduits, and money market
funds. Many benefitted from the financial support of their parent during the
financial crisis. Thus, he recommends that shadow banking vehicles or funds
that are sponsored or operated by banks should be consolidated on to bank
balance sheets. While acknowledging that consolidation might require changes in
accounting rules, which could take time, the senior official maintains that
these vehicles and funds should be treated as consolidated in the application
of Basel 3
regulatory capital requirements.
Even where a shadow bank is not de facto or
de jure part of a banking group, he continued, many are fundamentally dependent
on banks through committed lines of credit. The central banker believes that
providing committed lines to shadow banks is riskier than providing such lines
to non-bank businesses, since shadow banks are liable to call on their lines
just when the banking system is coming under liquidity pressure itself.
Noting that this should be reflected in regulations
on banks’ liquidity exposures, Mr. Tucker suggested that the draw-down rate assumed in the Basel 3
Liquidity Coverage Ratio should be higher for committed lines to financial
companies than for lines to non-financial companies. This would result in banks
holding more liquid assets against such exposures.
Claims on money funds have, in effect,
become monetary assets in the hands of savers, noted the official and, in parts
of the world, especially the US ,
they are treated like current accounts. Given the restrictions on their asset
holdings, he said, they resemble narrow banks in mutual-fund clothing.
For a normal open-end mutual fund, he noted,
the value of investments in it
fluctuates with the value of the vehicle’s asset portfolio. By contrast, most
money funds hold themselves out as offering par under any circumstances; when
they break the buck, they must unwind. Their investors run at that prospect,
said Mr. Tucker, and so the funds themselves are flighty investors.
Compared to most types of shadow banking,
money funds do not borrow in the usual sense. But by promising par, they are in
effect incurring debt-like obligations, he reasoned, and can be exposed to
leverage. Thus, he recommends that money market funds be required to choose
between being Variable Net Asset Value (NAV) funds or Constant NAV funds, with
any remaining CNAV funds subjected to capital requirements of some kind.
Moreover, they all should be subject to gates or other measures that can be
used to delay withdrawals in order to make runs less likely.
There must be a globally consistent approach
to regulating money funds, he emphasized, and the US
is crucial in this regard since the largest money-fund industry in the world is
based in the US .
Further, the US
money market fund industry is internationally active; lending to banks,
corporations and sovereigns around the world. This fact underlines the
importance of the outcome of the deliberations of the SEC and of the Financial
Stability Oversight Counsel in this area.
While hopeful that US authorities will take
action, observed the UK
official, if they do not, the EU and other global authorities will need to determine
what if any measures they could sensibly take to make the financial system more
resilient to the fault line that the money fund industry currently represents.
One possibility would be for bank regulators to limit the extent to which banks
could fund themselves short-term from US money funds and from other fragile and
flighty sources, including CNAV money funds domiciled elsewhere.
The Deputy Governor emphasized that such a
policy need not be targeted at US
funds per se. Rather, it could be cast in terms of the liability structure and
sources of funding of the banking system. The Basel 3 Net Stable Funding Ratio
could be employed. He also noted that on some fronts, notably transparency, the
EU should aim to catch up with the progress the US has already made.
Some shadow banks are businesses, such as
securities dealers and finance companies, and not funds or vehicles. If they
are financed materially by short-term debt, Mr. Tucker believes that they
should be subject to bank-type regulation and supervision of the resilience of
their balance sheets. In the EU, many dealers are investment firms and thus already
subject to the same Directives as banks on capital adequacy. But this is not
true of finance companies in many jurisdictions. The central bank official
suggested that there should be a size threshold for applying bank-style capital
and liquidity regulation to such non-bank banks.
For non-banks, he continued, any client
moneys and unencumbered assets should be segregated and should not be used to
finance the business to a material extent. It should, however, remain
permissible for non-banks to lend to such clients on a collateralized basis to finance
their holdings of securities, such as margin lending. This is an area where
regimes vary enormously around the world or are non-existent. For example, the US domestic regime is stricter on this than Europe . Mr. Tucker called for a global discussion in this
area.