The dominance of hedge funds and other shadow banks grows, as does the likelihood of a disaster. It's past time to put them on a leash.
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| Shadow Banking |
BlackRock's "Global Outlook for 2023" portrays a dismal picture. In the coming year, the world's most influential wealth manager forecasts a harsh recession and an unpredictable investing climate. Contrary to expectations, central banks would not be able to rely on their assistance in an emergency. The analysis ignores the fact that so-called "shadow banks," such as BlackRock, represent a huge systemic danger. In December, the President of Germany's Federal Financial Supervisory Authority (BaFin) raised worry about the non-bank financial intermediaries' lack of regulation. The Basel-based Bank for International Settlements (BIS) warned of the increasing danger presented by financial service providers a year ago.
But what exactly are shadow banks, and why are they so dangerous?
Shadow banks are financial market participants such as money market funds, hedge funds, and other investment funds, as well as credit insurers that perform banking functions but are not banks themselves. They, like banks, can lend money and aggregate the assets of their customers. Banks, on the other hand, are unable to technically generate money. As a result, you cannot manufacture book money and increase the amount of money in circulation. They cannot borrow money from central banks, unlike banks. Most crucially, unlike banks, shadow banks are not regulated by the government.
In theory, it makes sense to pool individual investors' funds in order to make bigger investments possible. It becomes an issue with non-transparent fund arrangements since it is no longer evident how the money is spent. Low interest rate policy in recent years has also pushed investors to embrace riskier kinds of investing in their pursuit of ever higher returns. As a result, warnings about regulatory agencies not paying enough attention to "non-bank financial intermediaries" have been issued on several occasions. Simultaneously, the power of shadow banks has expanded dramatically. In 2019, they managed about half of global financial assets, far more than traditional commercial and investment banks.
A disastrous miscalculation of systemic risks in the banking industry not long ago pushed the world's developed nations into a devastating recession. The international financial crisis will be fifteen years old in 2023. On September 15, 2008, one of Wall Street's oldest and most prominent investment banks, Lehman Brothers, went bankrupt. The effects were severe, and they may still be felt today. Attempts by the then-US government under George W. Bush to stabilize the banking industry with an extraordinary 700 billion US dollar rescue plan failed to avert a worldwide financial system collapse. A good year later, the eurozone was shaken by a mix of a national debt crisis, a financial crisis, and an economic catastrophe. International trade relations came to a standstill. Millions of jobs were lost worldwide.
In the ten years following the crisis, aggregate economic losses in the United States were projected to be $70,000 per capita. The loss of faith in political actors, who were powerless in the face of the financial system's unleashed energies, is more difficult to measure than the economic harm. The afflicted financial institutions were "too large to fail" because to their sheer size and systemic importance. They were not permitted to declare bankruptcy since the ramifications for the worldwide financial system and the actual economy would have been far-reaching. Dissatisfied with the bailout of banks at the expense of taxpayers and the concentration of global financial wealth in the hands of a small group of the super-rich, the "Occupy Wall Street" movement mobilized global protest.
The international community appeared to have learnt from its mistakes. At the 2009 G20 conference in Pittsburgh, leaders decried the "period of irresponsibility" and committed to implement regulatory steps to curtail high-risk financial transactions. In the United States, the Obama administration enacted the Dodd-Frank Act, a law designed to enhance financial market stability by requiring greater openness and accountability, as well as limiting state bailouts of financial firms at the expense of taxpayers. Banking regulation has also been substantially standardized in the European Union. The regulation of capital, which requires banks to retain proper cash as a buffer to protect themselves from danger, was a significant move. In addition, instruments were established for regularly evaluating the effectiveness of the reforms. The idea of introducing a financial transaction tax also met with great public support. It should slow down financial transactions, make speculation unattractive and share the costs with the financial sector. When"Tax against poverty" , the revenue generated should be put at the service of sustainable development. To date, its introduction has failed due to resistance from powerful lobbyists.
Even though some of the restrictions implemented have already been reversed during Donald Trump's administration, banks are now subject to far greater supervision than they were in 2008. The situation is different with shadow banks, despite the fact that they provide bank-like services and continue to engage in the non-transparent securities transactions that caused the 2008 financial crisis. Today, it is difficult to deny the systemic importance of non-bank financial intermediaries. The so-called Big Three asset managers, BlackRock, Vanguard, and State Street, have a disproportionate amount of authority. They will control 79 percent of the US exchange-traded fund (ETF) market by 2022. With more than 8,
Large asset managers have long been "too big to fail," similar to banks during the financial crisis. When investors withdrew money from money market funds during the corona epidemic and the shadow banking business model threatened to collapse, central banks provided significant support. As a consequence of vigorous lobbying, the international financial regulator, the Financial Stability Board, has yet to classify shadow banks as systemically significant (FSB). Economist Daniela Gabor compared shadow banks to nuclear power plants as "possibly necessary, but also prone to catastrophic system breakdown". She warns of the expanding involvement of shadow banking and development funding in low-wage nations. Given the severity of the national debt crisis, the latter is especially difficult.
More than two-thirds of all nations globally remain critically indebted a decade and a half after the international financial crisis and a global epidemic. It is critical to pay special attention here since speculation on rising government bond prices in light of rising national debt was one of the triggers for the euro crisis in 2009. As a result of the epidemic and the war in Ukraine, private capital has been steadily withdrawing from emerging countries since March 2022. Despite regulatory efforts in the financial sector, worldwide wealth concentration has increased. According to Oxfam estimates , in 2009 the combined wealth of the poorest 50 percent of the world's population was equivalent to the wealth of the 380 richest people in the world. Ten years after the financial crisis, a small group of 26 people owned as much as the poorer half.
The mobility of citizens According to Finanzwende, the financial market is still far too large. On the regulation and unbundling of shadow banks, a complete list of measures has been proposed. She suggests, among other things, that the Cartel Office limit asset managers' market power in order to undermine the Big Three's oligopoly. She also wants shadow banks in Europe to be directly supervised by the European Central Bank, non-transparent funds to be thoroughly scrutinized before they are allowed, and money market and credit funds that do not adhere to the core concept of an investment fund to be absolutely prohibited. A fee-financed safety net at the central banks is intended to ensure that open-ended funds carry liquidity support themselves. In addition, the citizens' movement proposes demerger measures to counteract conflicts of interest and distortion of competition. In order to create concrete alternative investment opportunities, calls for the creation of a citizens' fund based on the Swedish model.
One catalog of recommendations with strategies to decrease risks from the shadow banking industry for severely indebted nations and developing economies is offered by the Dutch Center for Research on Multinational Corporations (SOMO).
The next catastrophe is already on the horizon. Dr. Doom, Nouriel Roubini, predicted towards the end of 2022 that the "mother of all crises" will hit us with an explosive combination of economic, financial, and debt catastrophes. imminent. 15 years after the failure of Lehman Brothers, it is past time to revisit the lessons learned and examine the regulatory gaps. For a long time, good solutions for mitigating the systemic risks posed by the shadow banking industry have been on the table. A financial transaction tax, which was devised years ago, would merely need to be dug out of the drawer. Banking regulation after 2008 has demonstrated that governance is achievable.
The author Sarah Ganter is a political scientist who runs the Global and European Politics department at the Friedrich-Ebert-Stiftung.
Source: IPG