Turner calls for radical action on shadow banking

Lord Turner, Chairman of the Financial Services Authority, at The Economist's inaugural City Lecture in London, January 21, 2009.

Story highlights

  • Lord Turner warns that shadow banking could foster "unsafe" borrowing and exacerbate economic boom and bust cycles
  • Non-banks are not something "separate from the core banking system, but deeply intertwined with it"
  • Turner heads a committee that aims to produce regulatory reforms to address the risks the sector poses
Shadow banking poses a constantly changing threat to broader financial stability and has to be closely supervised and regulated to ensure it does not foster "unsafe" borrowing and exacerbate economic boom and bust cycles, the UK's leading financial regulator has said.
The sprawling array of non-banks that extend credit and provide other bank-like services are "not something parallel to and separate from the core banking system, but deeply intertwined with it ... We need to ensure that our regulatory response appropriately covers shadow banking as well as banks," Lord Turner told an audience at the Cass Business School in London.
The chairman of the UK's Financial Services Authority urged his fellow regulators to think broadly. "This time we need to ensure that we are sufficiently radical. But also not fool ourselves that any set of reforms we can now design will be sufficient to make the system permanently safe."
Lord Turner's views are closely watched because he heads a group of global regulators charged with coming up with plans to make the sprawling $33tn sector safer. Working under the auspices of the Financial Stability Board, Lord Turner's committee aims to produce by the end of the year both an analysis of shadow banking and a package of regulatory reforms to address the risks the sector poses.
FSB chairman Mark Carney has already said the shadow banking work is a top priority because stressed banks, particularly in Europe, need help meeting the world economy's credit needs.
Lord Turner said the committee was looking at how to make safer the many different financial products that mimic banking services, including securitisations -- the process of bundling individual loans and selling slices to investors -- and money market funds that promise investors instant access to cash.
The group may also propose minimum haircuts and margins for "repo" and other secured lending to minimise their pro-cyclical effect in falling markets. During 2007 and 2008, falling prices led lenders to increase margin requirements, forcing borrowers to sell assets to post collateral, which drove assets down further.
Investors, too, have contributed to the risks through what Lord Turner called "myopic risk assessment" and unreasonable demands for low-risk, highly liquid, yet high-yielding assets.
"We need to design a system which faces end-investors with reality, and does not allow the development of a set of claims whose apparent combination of risk, return and liquidity is in aggregate unsustainable."
Securitisations, the type of shadow banking that proved particularly toxic in 2007 and 2008, may have fallen by as much as 90 per cent, but "we should not take the decline in some specific indicators of shadow activity ... as suggesting that the risks have gone away," Lord Turner warned. "Any system this complex will defy complete understanding."