Ireland and Luxembourg call for tighter shadow banking regulations

Ireland and Luxembourg have stepped up their calls for stricter global regulations on shadow banks to reduce the risk of financial turmoil from a sector encompassing hedge funds, crypto firms and more.

Senior officials in the two EU states that together host shadow banking with assets of around €10tn want regulators develop stricter standards for this sector, which is still subject to a lighter regulation than traditional lending despite accounting for around half of financial system assets.

Vasileios Mdouros is the deputy governor of the Central Bank of Ireland’s financial regulation. He said that Dublin will call for an “overarching and comprehensive” framework to contain the risks of an industry which has grown by more than twice since the global financial crisis of 2008.

Marco Zwick is the head of funds regulations at Luxembourg’s regulator Commission de Surveillance du Secteur Financier. He said: “We know that a crisis on a global scale cannot be solved by a national initiative alone. It requires broader action.”

According to research by the Financial Stability Board, total shadow bank assets are now $240tn. After a series of crises, the Financial Stability Board has been pushing for stricter regulations. The sector is less regulated than banking because firms do not have retail deposits.

The vast differences in the institutions that fall under shadow banking labels also complicate the process of setting global standards. Ireland and Luxembourg have been at the center of recent crises. Rapid selling by funds in these countries forced the Bank of England into launching a £65bn programme to buy bonds in September.

Dublin has responded by requesting a framework that would apply to all shadow banks, and that would not only consider the risk posed by individual firms but also the impact on the entire system. Madouros stated that “this is a field where we would like to see real progress.” He added that the central bank will soon release a document outlining its recommendations.

Zwick stated that Luxembourg had “actively worked” to push for tougher global regulations, by being a member of groups like the Financial Stability Board which sets global policies on financial stability and Iosco which coordinates global securities regulation. There was more work to be done on “further developing and enhancing existing standards for liquid risk management”.

Experts say that countries are acting out of self-interest when they call for stricter global rules, rather than imposing them themselves.

Richard Portes is a professor and co-chairman of the European Systemic Risk Board’s joint expert group for shadow banking. He also serves as the co-chairman of the European Systemic Risk Board’s joint expert panel on shadow banks. “There’s a reputational risk [to Ireland],” said one financial stability expert, adding that more turmoil emanating from the sector “could make investors and European authorities more cautious and give Ireland a hard time.”

One financial regulator stated that it was “really difficult” for the national authorities to “actually determine” the global risks posed by the funds with headquarters in their country.

Globally, there are already efforts underway to improve liquidity of money market funds and other open-ended funds.

Ireland’s €4.6tn Fund Sector, which is roughly 13 times larger than the gross national product of the country, cannot rely on a current approach that focuses on investor protection.

Madouros added that the shocks may have implications for the wider economy.

The UK is also looking for faster progress in regulating shadow banks. Andrew Bailey, BoE governor, criticized Brussels for its slowness in implementing money market fund reforms which have been globally agreed. He told lawmakers that the UK is taking action but “we still need the EU” to follow suit.

Recent criticism of the current shadow bank regulatory regime by the European Central Bank (ECB), which is responsible to police the largest banks in the eurozone, was inadequate.

Madouros stated that Ireland faced a “relatively small” risk from its funds sector, but the central bank was responsible for ensuring these funds didn’t jeopardize regional or global stability.