We do not agree with the approach taken by the EBA and the European Commission (EC) which assumes that the risks posed by all entities deemed to be “shadow banks” are the same. As the work of the Financial Stability Board (FSB) has demonstrated, the term “shadow bank” covers a huge and diverse range of financial services products and regulatory policies should reflect that.
A majority of the FLA’s member companies are non-banks. They all operate in the real economy and are already subject to a wide range of regulation, including the new UK Financial Conduct Authority’s regime regulating the consumer credit markets. That regime applies not just to our members in the consumer markets but also to many firms in the business finance markets, because it covers lending to a large number of small businesses.
Our members support the social and financial well-being of millions of consumers and small businesses. Consumers enjoy a higher standard of living through the access responsibly-provided credit gives them to essential goods such as furniture, electrical equipment, clothing and motor vehicles. And asset finance (leasing and hire purchase) allows small businesses to access the funds they need for investment and growth. The European economy needs a healthy, vibrant credit market to generate growth and further inappropriate regulation would jeopardise that aim.
The consultation paper considers the risks associated with “shadow banks”. We address each in turn below.
• Run risks and/or liquidity problems – “runs” occur where there is reliance on short-term funding, which in practice is not a significant feature of funding for non-bank lenders. So long as the maturity profile of a company’s debt is longer than that of its assets, it will self-liquidate without recourse to the capital markets or funding by moving into run-off. In consequence, non-bank lenders do not constitute a systemic risk of this kind.
• Interconnectivity and spillovers – non-bank finance companies are funded through a variety of means including securitisation, syndicated bank loans, the capital markets, and parent company funding. This mix allows them to spread their risk so that they are not over-exposed. Moreover, Article 395 of the Capital Requirements Regulation (the basis for the proposed new guidelines) provides that “an institution shall not incur an exposure […], to a client or group of connected clients the value of which exceeds 25% of its eligible capital”. Any risk of contagion from the failure of a specialised provider is therefore, in any case, already contained by existing EU prudential regulation.
• Excessive leverage and procyclicality – this is not a feature of the markets in which FLA members operate. The FSB stated in its 2012 Global Shadow Banking Monitoring Report that this effect often arises as a result of inter-connectedness (see above for why this does not apply).
• Opaqueness and complexity – non-bank finance companies are either “captive” companies (i.e. the finance arms of manufacturers or retailers) or independent companies which specialise in a single product or a range of products. Many of the parent companies of captive finance companies are well-known and their ownership structure can easily be checked on the public record, for example via Companies House in the UK.
The paper argues that “shadow banking” may have emerged to circumvent existing regulation (regulatory arbitrage). This is certainly not the case for non-bank lending to consumers and businesses, which came about largely in response to the needs of consumers (e.g. at the point of sale on the high street or in motor dealerships), and to provide businesses with a wider choice of funding channels than was available from traditional bank lenders.
There is no evidence that risks arising from non-bank lenders in this arena have ever endangered the financial system, even during the recent global economic crisis. There have been no Government bail-outs for such finance companies, and no public money has been put at risk. The non-bank lenders which have failed during this period have occasioned no threat whatever to the operation of financial markets, regulated banks, or consumers. In the event of such a lender becoming insolvent, its customers would not be at risk, because their credit agreement would continue; and the lender’s assets would be realisable in an orderly fashion over a relatively short timeframe for the benefit of creditors. In other words, credit differs in these important ways from other financial products, because the main risk lies with the lender rather than the consumer.
The FSB’s Global Shadow Banking Monitoring Report published in November 2012 (and based of the views of regulators from 25 jurisdictions) found that non-bank finance companies:
• Played an important role in providing credit to the real economy, especially where they filled “credit voids that are not covered by other financial institutions.”
• Did not pose significant systemic risks (this did not preclude monitoring of the risks).
The EBA’s blanket definition of shadow banking is unworkable, and would make it almost impossible for banks to assess their risk exposure because the scope is so wide. We urge the EBA to follow the approach already taken by the FSB, which is currently considering the risks posed by different types of firms, including finance companies. Otherwise, the EBA risks unnecessary damage to important sectors of the economy, endangering recovery
We support the EBA’s view that it is premature to introduce a quantitative limit to banks’ exposures at individual exposure or aggregate level, not least because the current definitions are so wide (see our response to Q1).
The elements listed for establishing effective processes and control mechanisms are current good practice amongst FLA members.
Similarly, we support the EBA’s approach in respect of the criteria for establishing appropriate oversight arrangements.
We agree with the elements listed in the draft Guidelines. Where the paper refers to setting ‘tighter limits to individual exposures’, we would like clarification of what ‘tighter’ relates to. We are concerned that if, in future, banks were required to set quantitative limits on individual exposures, this would be unmanageable. This is because daily market fluctuations could result in a shadow banking customer inadvertently exceeding the prescribed limit. It would also involve costly changes to IT systems.
We prefer Option 2, which is more flexible. Option 1 is unnecessary because it does not bestow any benefits on a bank which complies with some of the elements of the principle approach.
Yes. It is important to have a consistent approach.
