BaFin warns of "massively growing" shadow banking sector

BaFin, the financial regulatory authority for Germany, operates as an independent federal institution headquartered in Bonn and Frankfurt, and is subject to the oversight of the Federal Ministry of Finance. At the International Club of Frankfurt Business Journalists, Mark Branson, the president of the Federal Financial Supervisory Authority, emphasized the significant growth of the shadow banking sector and called for urgent and robust regulatory measures. He advocated for strong global regulations and heightened surveillance in addressing the ambiguous areas within financial markets.

What are shadow banks?

Shadow banks are entities in financial markets that emulate bank-like functions but operate outside traditional banking regulations. Examples encompass securitization companies, hedge funds, money market funds, pension funds, and asset managers lacking a banking license. The need for more stringent oversight in this sector arose following the 2007/2008 financial crisis. Despite the implementation of stricter regulations for traditional banks since then, the shadow banking realm remains a focal point for regulatory concerns.

Increase in European shadow banking

As reported by Spiegel, the pursuit of higher yields amid historically low-interest rates has propelled the shadow banking sector to expand by over 50% in Europe since 2019 alone. The president of BaFin underscores the associated risks, emphasizing that the comparatively lighter regulatory environment for shadow banks, in contrast to traditional banks, may expose them to heightened risk levels, potentially resulting in substantial losses. This substantial growth in the sector has consequently amplified the overall risks it poses.

Concern over the crypto market

According to Spiegel, the BaFin president has expressed apprehensions regarding developments in the crypto market. Following the November 2022 collapse of the FTX crypto exchange, a platform for digital currencies like Bitcoin and Ether, investors are expressing concerns. The BaFin president suggests that the market's collapse might serve as a timely warning, underscoring the importance of learning from these lessons. He emphasizes the need to avoid leaving the shadow banking sector unregulated under the assumption that it will die out.

 

Lack of risk awareness

During an interview with the European Central Bank, Mark Branson emphasized that stringent standards have guided supervisory practices in the euro area since the 2008 financial crisis. He underscored the pivotal role these measures have played in fortifying the resilience of the financial system and reinstating confidence. However, the BaFin president conveyed ongoing concerns about incomplete reforms, including the implementation of Basel III, the European deposit insurance scheme, and discussions regarding the risk weighting of sovereign bonds on bank balance sheets.