ECB needs new tools to tackle shadow banking risks - Constâncio

Vice-president says central bank will need a broader arsenal to cope with risks in the shadow banking sector, suggesting the US and UK both have powers that could be useful

Vítor Constâncio

The European Central Bank (ECB) needs to be equipped with new tools to cope with risks originating in the shadow banking sector, Vítor Constâncio, the ECB's vice-president, said on Monday.

The ECB lacks certain instruments that some other central banks – notably the Federal Reserve – have in their toolkits, Constâncio said during a speech at Chatham House.

Constâncio stressed the term ‘shadow bank' should not be seen as pejorative, but instead indicated these institutions conducted operations that were not fully captured by data on flows of funds and monetary statistics.

Shadow banking encompasses a broad range of activities. The Financial Stability Board defines shadow banks as any non-bank entity that engages in credit intermediation. Many firms that fall under this definition do not engage in particularly risky activities.

Nevertheless, the ECB needs new powers if it is to cope with regulating the sector, Constâncio said. He suggested there were a number of areas in which the ECB's role could be strengthened.

For example, Constâncio said, the Fed has the power to add certain non-banks that are "financially significant" to the list of institutions it supervises. The Fed also has counter-cyclical powers over margin requirements in securities transactions.

Constâncio also noted that some jurisdictions, such as the UK, have powers to set caps on loan-to-value and debt-to-income ratios. Furthermore, tougher capital charges for the "equity participation" of banks in non-banks would make for a clearer boundary between the shadow and regular banking sectors, he said.

The shadow banking sector has been growing in Europe in recent years. Statistics published last week by the ECB showed the sector grew from a quarter to a third of the eurozone financial system in the past decade.

With the ECB due to take on its role in Europe's Single Supervisory Mechanism (SSM) in a matter of weeks, Constâncio emphasised that macro-prudential tools "need to be bold" but would not "impinge" on the central bank's monetary policy.

He explained that with the financial cycle generally longer and not synchronised with the business cycle, it was important for a central bank to have a second set of tools to deal with threats to financial stability.

He did say, however, that monetary policy could be used as a "last line of defence" in "extreme cases" of financial instability.

Constâncio said the SSM "goes a long way towards harmonisation" in Europe. He described it as "one system" rather than two tiers, with the ECB sat above national central banks.

All work will be done based on one centrally agreed manual, risk profiling will be standardised, and the ECB can choose to directly supervise any bank it deems necessary, he said.

Wider regulatory harmonisation is a more contentious issue. Speakers on a panel last week, including Bank of England deputy governor Jon Cunliffe, said total harmonisation of global regulation was likely to be unattainable.

This article was originally published in sister title Central Banking.