The U.S. financial system is unique in that its evolution
has resulted in a shadow banking system of considerable scale and institutional
diversity, explained Dennis Lockhart, president and chief executive officer of the Federal Reserve
Bank of Atlanta. Shadow banking, which Lockhart defined as “financial services
providers and credit intermediaries that operate without a bank charter,”
accounts for roughly 40 percent of credit intermediation. Firms that could be
classified as shadow banks include money market mutual funds, broker/dealers,
nonbank finance companies, business development corporations, hedge funds,
pension funds, and peer-to-peer online lending platforms.
However, while the banking system and shadow banking system
compete directly for similar business and serve similar functions, nonbanks are
much less regulated than banks, and that regulation is largely not prudential
in character, warned Lockhart at the Georgia Law Review symposium at the
University of Georgia. He explained why he believes market discipline may not
be enough and why “Selective supervision and regulation [of shadow banking] is
both possible and desirable.”
Market discipline.
While the liabilities of the shadow banking system come predominantly from
professionally managed money sources, and the spread of firms and activities
classified as shadow banks or shadow banking may mitigate the risk of massive
concentrations, “shadow banking activity is large, growing, and opaque.”
“A robust regime of monitoring is justified, in my opinion,
because of the natural tendency in our economic system for activity to migrate
to where it is least regulated,” said Lockhart. “I also do not believe we have
to choose between complete exemption from prudential regulation and a wholesale
extension of the existing framework of regulation developed for banks.”
Selective
supervision. As a result, Lockhart suggests close monitoring with selective
supervision by variably monitoring and supervising institutions and activities
in the shadow banking system. The concept of differential supervision also is
applicable among traditional banks. “The approach recognizes significant
distinctions between larger banks and community banks. I expect continuing
refinement of supervisory methods along this line,” said Lockhart.
The “true north” of any expansion of the regulatory overlay on
shadow banking should be to protect the financial system's ability to support
the general economy, Lockhart concluded.
