These days, we commemorate a somber anniversary. Indeed, the collapse of Lehman Brothers and the subsequent financial, economic, and political chaos that ensued were of such magnitude that, ten years later, we have barely recovered from either the economic or the political consequences. Most opinions today focus either on the specific events that led to the so-called Great Recession or on whether we have taken adequate measures to prevent a crisis of similar scale and outcome from recurring.
It remains concerning that diagnoses vary so widely. Even among those of us who experienced the crisis firsthand, there seems to be no clear understanding of what led us to this situation. One only needs to examine, in the Spanish context, the wide range of opinions expressed by renowned experts in the parliamentary Inquiry Commission on the financial crisis. Perhaps this is logical, as such a profound crisis can hardly have a simple, unequivocal explanation. Therefore, it would be prudent to refrain from intervening in the debate, although it is difficult to resist the urge to offer a proposal to avoid making the same mistake next time.
Among these, the role that shadow banking played both in the inception and the spread of the crisis throughout the financial system stands out. Most alarmingly, however, this phenomenon is more active than ever today and represents a serious threat to financial stability. Mario Draghi recently warned of this, lamenting that shadow banking had escaped regulatory efforts by authorities and proposing to subject this sector to more rigorous controls, similar to those of traditional banking. The concern of the President of the European Central Bank is understandable, as the shadow banking sector now represents 40% of the European Union’s financial system, according to figures from the European Systemic Risk Board, whereas just a couple of years ago it barely accounted for a quarter. There is no doubt that shadow banking continues to develop vigorously, fueled by increasing financial regulation. For some, including myself, this fact has been a constant source of concern for some time, and I have expressed this in various writings and conferences. I am not alone in this, of course. The International Monetary Fund (IMF) and the Financial Stability Board (FSB) are responsible for measuring the evolution of this activity, i.e., credit intermediation that occurs outside the traditional banking sector. This activity is carried out by financial entities—hedge funds, real estate funds, investment vehicles—which, while not banks, perform functions with similar risks but without the guarantees offered by banking regulation, and consequently, can pose a danger to financial stability.
Despite the efforts of the IMF and the FSB, no measure is serving as a bulwark against the development of shadow banking, which has soared to account for more than 25% of global financial intermediation. Nothing is slowing it down; on the contrary, the intensity of banking regulation is stimulating its growth, because the more banking regulation tightens (capital requirements are ten times higher than those in force before the crisis), the more the benefits of regulatory arbitrage increase. Authorities are aware of the dangers of this dynamic. We must not forget that the crisis began with the collapse of Lehman Brothers and the bailout of AIG, two textbook cases of shadow financial activity. It is worth noting that neither was a bank, but rather a brokerage firm and an insurance company that engaged in high-risk activity, completely different from the commercial banking operations carried out by Spanish banks.
That initial trigger caused a deep and widespread banking crisis among developed countries, leading to a tightening of banking regulation and supervision, which is very demanding for traditional banks, but paradoxically has left out the activities that were at the origin of the crisis. The question we now ask ourselves is whether the regulatory process is truly making the international financial system more robust and secure. Undoubtedly, this is the case for banks, which are now much more liquid and solvent than before the crisis. Specifically, Spanish banks currently have between two and three times more capital than a decade ago, and between four and six times more if we include resolution capital, MREL. Has the same progress been made in controlling the dangers arising from the shadow banking system? Without a doubt, the answer is no. Moreover, shadow banking shows greater dynamism the tougher banking regulation becomes.
One of the practical difficulties in controlling this sector is the lack of detailed statistical information on shadow banks. The FSB is making a great effort to understand and identify those shadow entities that may represent a systemic risk, and in parallel, it has launched a process to identify systemically important institutions, SIFIs in the English acronym, for which enhanced regulation and supervision have been planned, as their failure would have effects on the entire system. This SIFI identification process is being extended to companies that are neither banks nor insurance companies, which is of vital importance if we want to avoid the risks of regulatory arbitrage in terms of solvency. But let us not forget another type of arbitrage, which is increasingly practiced today to circumvent the rules governing investor and consumer protection, given the demanding conduct regulations approved after the crisis. Such arbitrage would have devastating effects insofar as it would expose investors to unassessed or unstated risks.
For all these reasons, it is necessary for global financial authorities to advance more quickly and decisively in curbing regulatory arbitrage within the financial system, because otherwise, we will end up with a secure, stable banking system, but a large, opaque, and potentially unstable shadow financial sector will have been created that will undoubtedly be the cause of the next financial crisis. Let us, therefore, put in place the appropriate means to prevent it.
José María Roldán, Chairman of the Spanish Banking Association
