FSB: Risky Business

Siddhidatri Mishra of the Financial Times reports on the Financial Stability Board.

In the backdrop of various countries coming to terms with the aftermath of the 2007-08 financial crises, the Financial Stability Board (FSB) had circulated the agenda of transforming shadow banking into resilient market-based finance.

The majority of the discussion in the committee revolved around the risks and benefits of shadow banking. Risks such as maturity mismatch and unpredictability of the sector were emphasised upon.  Other risks that were spoken about included the large size of the sector and the worry that investors do not know with whom or where their money is being invested. The success of the Dodd Frank Act, passed after the Great Recession by President Obama, was also questioned. The Act was supposed to promote financial stability in the United States of America. However, recent reports have shown that the Act has failed to uplift the economy and has led to the deterioration of the formal banking sector with only 30 per cent of the banks offering free checking accounts- a fall from the previous statistic of 75 per cent.

The committee reached a common consensus that the major contributors to the growing sector of shadow banking include subprime mortgage (mortgage made of people with low credit ratings), hedge funds and profit shifting.

The committee also discussed the benefits of shadow banking with great enthusiasm. The delegates agreed that the complete eradication of this particular banking system is not a feasible solution. They defended this statement by pointing out that shadow banking has led to the increase in the number of investors by providing alternative means of funding and risk diversification. It also helps convert illiquid assets to liquid assets and support smaller companies. In fact, shadow banking has helped achieve the macroeconomic aims laid down by the Government by providing some part of the population with an alternative means of livelihood and reducing the borrowing of money from the Government.

While the first day of the committee was a fruitful one in helping lay down the foundation of the issues facing the committee, it did not offer any long-term solutions. It is pertinent that the FSB realises the importance and magnitude of the task they have been assigned with.

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