Shadow Banking and our economies

 

Frederico B. Vasconcelos

Attorney for Central Bank of Brazil

           Globalization is a concept known in the financial system environment since the mid-eighteenth century, when the direct interference in a country of some practice occurred in another was already noticed, although separated by oceans and great distances. Barry Eichengreen, a renowned economist and professor at the University of Berkeley, in his book “Globalizing Capital”[1], shows that the changes effected by the monetary authority in England, aiming balance of internal accounts, necessarily generated the need for systemic equalization by saving instruments immediately in nearby countries and successively more remote land in a wave of assimilatory movements.

             From that time to the present, as a collective reaction of the countries to offshore developments, globalization has been noticed more strongly because of the speed of information, enhanced by the exponential rate of real time to a remote science fact. With that, the changes caused by financial instruments in any country, are not restricted to the limits of their territory, imposing immediate reaction to the world. To complicate the situation somewhat, the natural dynamics of financial complementary nature on the planet has created an environment that lives and grows outside of the formal control of the global banking system, named Shadow Banking.

           According to the definition of the Financial Stability Board – FSB[2], Shadow Banking is the “credit intermediation involving entities and activities outside the regular banking system” concept, also known as Market-Based Financial. This financial phenomenon involves several very common operations in daily business, but has a very important feature that gives it relief, marginal ongoing banking supervision.

             These events are observed by the monetary authorities, though its monitoring began to occur in more detail only from 2011, when formal reports of their impact on the global financial system began to show. Every year the FSB publishes global monitoring report of the phenomenon, to measure its influence in the financial and banking environment, considering the voluminous amount of loans that are held to the banking system regulated margin. In the latest report[3], issued on 10.30.2014, begins to outline the exorbitant size of that environment.

               So what does that matter to the poor mortals and what relevance this event has on people’s lives?

              The flow of capital and assets must be accompanied not only in the narrow limits of a country, but worldwide because of the intertwining of the financial and banking systems, seeking ideal similar defend – sometimes antagonistically between countries – stability of the local currency and healthiness these systems.

               The breakdown of the stability of a financial system, as it happened in 2008, in the crisis started in the US, from the collapse of the banks Merrill Lynch and Lehman Brothers, is the main target to be fought with the regulation, using its instruments to monitor and, in some cases, intervene if purging-phenomena that can cause systemic risk.

                  At this point, the important concept here treated gains more relevance due to the fact that even in a controlled system it failed to prevent financial catastrophe of global dimensions, let’s fence it in a parallel circuit, which large volumes of assets are traded, completely out of the regulation of the banking system, showing impacts directly on its results.

             According to the International Monetary Fund – IMF[4], only in emerging countries assets moved by 2013 reached US$ 7 trillion, and its growth is much higher than the assets traded through the regulated financial institutions. China increases around 20% each year its turnover in the Shadow Banking environment. In Brazil, the assets that harvest grew from 25% to 50% of GDP between 2002 and 2013.

              Is a cash flow of this magnitude and in these conditions, however, it can undermine global financial stability, due to abrupt changes not monitored, with further negative impacts that the crisis experienced in 2008. This outlook is so real that the chairman of the Bank of England and head of the FSB, Mark Carney[5], indicates that the Shadow Banking in emerging markets will be the driver of the next global financial crisis.

               A few days ago the Swiss National Bank changed its exchange rules causing worldwide commotion and upheaval in the financial and banking markets. This movement occurred within the formal banking system and was able to achieve sizeable financial operations. Imagine in a financial environment that is estimated to have moved US$ 67 trillion in 2011 without the due regulation. Any sudden movement would cause severe shock in the world economy.

                 If this cycle has some economic advantage that can be extracted, time will answer, considering the incipient knowledge of the actual effects of the global system. Admittedly, the positive use of this financial field, or the elements that it can bring, should be anticipated for the close monitoring of their interaction with the regulated banking system.

                    For no other reason, the Bank of England has been promoting every September, during 5 days, a meeting in London to Central Banks of members from around the world, targeting the exchanging of experiences and the tuning of regulatory instruments to monitor the phenomenon.

                 The existence of the monitoring of ongoing operations in this environment, as a way of macro-prudential policy and risk management, should be a priority of the monetary authorities, because while Shadow Banking businesses are natural and legitimate, its growth shows youthful vitality, imposing the efficient adaptation of the economic mapping tools on this important actor on the world stage.

 

Obs .: This article does not represent the opinion of the Central Bank of Brazil

[1]     Eichengreen, BARRY. Globalizing Capital: A History of the Monetary System.

[2]     Financial Stability Board (http://www.financialstabilityboard.org/).

[3]     Global Shadow Banking Monitoring Report 2014 (http://www.financialstabilityboard.org/wp-content/uploads/r_141030.pdf?page_moved=1)

[4]     http://www.imf.org/external/pubs/ft/gfsr/2014/02/pdf/c2.pdf

[5]     The Economist – http://www.economist.com/news/leaders/21601826-shadow-banks-helped-cause-financial-crisis-better-regulated-they-could-help-avert-next

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