In a December 4 2012 research report, the IMF discussed their views on how to best regulate shadow banking. The paper, “Shadow Banking: Economics and Policy,” has some interesting points that we discuss below. The paper was written by Stijn Claessens, Zoltan Pozsar, Lev Ratnovski, and Manmohan Singh; as far as we can see, Pozsar and Singh are the IMF’s leading thinkers on all things collateral, stability and shadow banking. On a related note, Finadium has the honor of speaking at two events in January 2013 featuring Manmohan Singh.
As most of the paper is a recap and review, especially for Securities Finance Monitor readers, we’ll focus on the new stuff covering regulating risk:
1) The authors see “a pressing need is to develop a comprehensive regulatory approach to dealer banks…. The crisis has made it clear that the regulation and supervision of broker-dealers was not rigorous enough and orderly resolution is a challenge. Yet, a comprehensive framework for regulating broker-dealers that is as well articulated as the one that exists for banks is lacking. Thus, systemic risks and puts to the safety net from dealer banks likely persist.” We’re going to agree wholeheartedly with this idea. We see repeatedly how different entities of the same holding corporation have different regulations, and the only way that regulators have of managing a firm’s entire risk is by convening a grand council to set things right. This is a haphazard approach to regulation and should be settled by establishing, as the authors note, a comprehensive regulatory regime.
2) “There is also need for progress on money market funds (MMFs).” The authors lay out what we already know here and don’t appear to be fans of any one of the proposals. As we’ve stated, we think that a floating NAV is the least worst solution. Yes, it will entail changes, but it is much better than the reserve fund or gates on investor withdrawals, which we think would kill money market funds outright. Part of the trouble in finding a solution is that regulators don’t want funds to build up systematic risk, but if these regulated funds get smaller and investors move assets to banks in individually managed cash accounts, they will still buy many of the same products. There is no gold standard here, so we suggest picking the least worst solution and move on.
3) “Finally, progress is needed as well on the tri-party repo market.” The authors are coming out strongly in favor of a new market utility for US tri-party repo and away from a reliance on BNYM and JPM. “While essential, current policy initiatives—limiting the duration of intra-day exposures and improving collateral management—do not address the fact that the heavy reliance in the United States on two private clearing banks (Bank of New York and JP Morgan) creates clear systemic risks. In principle, these functions could be transferred to a “market utility,” as is the case in some countries. This would make the two banks less systemic and segregate the risks of tri-party clearing, easing official support if required. More generally, how the tri-party market can be strengthened without compromising its role as a key intermediary between banks and broker-dealers and between mutual and pension funds requires more study.” We don’t agree – we think that a market utility could be as prone to failure as BNYM or JPM, or put another way, any of the three could need government intervention as easily as the other. Further, the Fed already looked at a NewBank for tri-party repo and discarded the idea. We don’t see them ready to jump back in so long as the daily unwind/rewind period gets tighter in the US markets, and soon (see the Fed’s latest comments on “increased supervision” of key tri-party repo participants here).
There are some other interesting nuggets here, including the idea that governments should issue more short-term securities in order to crowd out private securities issuance for investors. The paper is worth a read for those interested.