Lifting the Veil: Regulation and Shadow Banking

The growth of shadow banking in recent decades has changed the concept of banking. It has meant less deposit-taking and lending and more market-oriented banking activities, including in particular a growing trade in securitized products. However, shadow banking is opaque; a problem that was underlined in the recent financial crisis. Does the experience of the financial crisis and its links to the riskiness of banking mean bank re-regulation is necessary? In the Canadian context at least, better reporting of bank risk seems to be a more appropriate way than re-regulation to prevent financial turmoil from arising in this area. Market-oriented operations should be more exposed to daylight, to enable a better evaluation of true bank risk, and regulatory agencies should require detailed reports on activities generating noninterest income. Better indicators of leverage need also to be developed, owing to leverage’s role as the principal channel of bank risk-taking.