A new quarterly index by the Deloitte Center for Financial Services shows that the threat of the shadow banking industry is not as great as regulators and market participants feared. However, with regulatory changes and financial innovation looming, the shadow banking system could creep back very quickly, the Deloitte research group cautions.
According to the Deloitte Shadow Banking Index, the volatile shadow banking system totaled $9.53 trillion at the end of 2011 – more than 50% below its peak in 2008 – and a figure considerably lower than many estimates. Interestingly though, securities lending is the only shadow banking activity that is twice the volume today compared to the Index’s baseline eight years ago. Securities lending data is based on data from Data Explorers and includes total value of all securities on loan by U.S. domiciled funds.
The Deloitte Center provides insight and research for banks, private equity firms, hedge funds, mutual funds, insurance providers and real estate organizations operating globally.
Its Index exists at least partly outside of the traditional banking system and does not have government guarantees in the form of insurance or access to the central bank. In addition to securities lending, money market mutual funds (MMMFs) and agency mortgage-backed securities (MBS) are among entities and activities included in Deloitte’s definition of shadow banking.
The index finds that that the shadow banking sector in the U.S. will likely remain suppressed in the near-term, though it is unlikely that it will cease to exist; repurchase agreements (repos) and securities lending, to name two components, are vital to the functioning of the modern financial system and will likely bounce back eventually.
The decrease in the size of the system is primarily due to regulatory headwinds against the system, said Deloitte. “Given that major regulatory efforts have either been enacted or are in the works to help reduce the size of this important sector – like the Financial Stability Board’s recommendations expected later this year, which we are tracking closely – this is a conversation that the market needs to have, said Don Ogilvie, the independent chairman of the Center for Financial Services. The Financial Stability Board outlined recommendations to promote enhanced regulation of banks interactions with shadow banking entities. The FSB is expected to produce a comprehensive analysis of the risks and regulatory responses before the end of 2012.
Within the shadow banking sector, agency MBS were the largest component, followed by repos, MMMFs, and non-agency MBS. As of the fourth quarter of 2011, repos share of the U.S. shadow banking sector stood at 29%, while MMMFs accounted for 28%. Securitization vehicles (ABS, non-agency MBS and CDOs) contributed about 34%, a slight drop from their peak of 39% in the first quarter 2010.
“With other size estimates ranging from $10 to $60 trillion, we think shadow banking is a concept continuing to look for a better definition,” said Adam Schneider, the executive director of the Deloitte Center for Financial Services.
“The purpose of the Deloitte Shadow Banking Index – focused on the U.S. market only at this point – is to help define and quantify the sector over time,” continues Schneider. “We believe this will allow a better measure of size, importance, effect of market and regulatory actions, as well as a way to assess the potential impact on regulated banking markets.”
Other key findings of the Index include: shadow banking in the U.S. reached a peak value of $20.73 trillion in the first quarter of 2008; also during the first quarter of 2008 the traditional banking sector’s assets were only about $15 trillion 28% less than shadow banking; at the end of 2011, however, the comparison reversed with assets in the traditional banking sector $8 trillion higher than shadow banking; dramatic growth of the sector occurred between late 2004 (the Index’s starting point) and early 2008, increasing nearly two-thirds in size; there have been dramatic changes to a number of the Index’s components, including money market mutual funds and activities relating to the government-sponsored enterprises.
Ogilvie says: “This recent decline does not mean that the shadow banking system is unimportant,” said Schneider. “It does mean, however, that it is highly dynamic, and operates amid a backdrop of economic volatility, regulation and significant changes already in the banking system.
“We expect that the components in the index will increase or decrease as new laws and regulations are adopted and as new financial products are created,” said Ogilvie.
(JDC)