Criteria for the Identification of Shadow Banking Entities

The main basis for the development of these criteria has been the guidelines on limits on exposures to shadow banking entities which carry out banking activities outside a regulated framework. As such shadow banking is a system of credit intermediation that involves entities and activities outside the regular banking system.

These specific RTS (Regulatory Technical Standards) consist of three main legal provisions addressing the following:

  • Criteria for identifying both shadow banking and non-shadow banking entities;
  • Definition of banking activities and services; and
  • Criteria for excluding entities established in third countries from being deemed as shadow banking entities.

Entities that are exempted or excluded from the application of for example EMIR and Solvency II, shall not be considered as shadow banking entities. In the case of entities established in a third country, the RTS differentiate between banks and other entities. Banks would not be identified as shadow banking entities provided that they are authorised and supervised by a supervisory authority that applies banking regulation and supervision based on at least the Basel core principles for effective banking supervision. The Basel core principles provide in this regard a sufficient basis for effective supervision, capturing effective risk-based supervision, and the need for early intervention and timely supervisory actions. Other entities would not be identified as shadow banking entities provided that they are subject to a regulatory regime recognised as equivalent to the one applied in the European Union for such entities in accordance with the equivalence provisions of the relevant European Union legal act.

The EBA assessed the shadow banking system, noting its complementary role of the traditional banking sector by expanding access to credit in support of economic activity or by supporting market liquidity, maturity transformation and risk sharing, thereby promoting growth in the real economy. The EBA noted also that the financial crisis had revealed fault lines in the shadow banking system which put the stability of the financial system at risk, e.g. a heavy reliance on short-term wholesale funding and a general lack of transparency. In this respect, the EBA identified some concerns regarding shadow banking entities, namely:

  1. run risk and/or liquidity problems;
  2. interconnectedness and spill overs;
  3. excessive leverage and procyclicality; and
  4. opaqueness and complexity.

These EBA guidelines focus on institutions’ exposures to entities that pose the greatest risks in terms of both the direct risk institutions face by being exposed to such entities and also the risk of credit intermediation being carried out outside the regulated framework. When an entity is not authorised and supervised or exempted or optionally excluded from the regulated framework or when the relevant services offered or activities performed are not within its authorisation, this entity should be identified as shadow banking entity, except where it does not offer banking services and does not perform banking activities. An example of shadow banking entities mentioned are Money Market Funds.

The DACT does support these RTS with the following main remarks:

  • The DACT believes that Money Market Funds (as an Alternative Investment Fund) should fall within the scope of supervisory review, but should not be automatically regarded as shadow banking entities. Money Market Funds are legitimate and professional institutions, and provide in a need in terms of potential asset classes to invest in.
  • The DACT believes an advantage of taking a broader approach would be a further improvement of supervision of entities with a potential systemic risk. Disadvantages would be increased legislation, complexity and work around potential controls.

In case you feel that the DACT can contribute in this process via webinars or an active exchange of information, please contact your DACT representative via:vaktechniek@dact.nl