By Martin North, cross-posted from the Digital Finance Analytics Blog.
Today we look at Shadow Banking in Australia, having set the scene by looking at the size of the global market and the core financial flows in previous posts. We are talking about players who are interpose themselves in credit flows outside the regulated banking system. Not all such players carry the same risks, and some behave more like banks than others, which is why the Financial Stability Board approach is to decompose players into different risk categories.
This definitional problem is relevant to Australia as the regulators here have distinguished between “prudentially regulated” and other players. The Australian Prudential Regulation Authority (APRA)
“is the regulator of the Australian financial services industry. It oversees banks, credit unions, building societies, general insurance and reinsurance companies, life insurance, friendly societies, and most of the superannuation industry. APRA is funded largely by the industries that it supervises. It was established on 1 July 1998. APRA currently supervises institutions holding $4.5 trillion in assets for Australian depositors, policyholders and superannuation fund members.”
APRA maintains a list of companies it regulates under ADI’s, General Insurers, Superannuation, and Life Insurers. Each sector has its own web area within APRA, but there is no one clear single list across all sectors, which makes tracking down the status of an individual company quite difficult. Each sector has its own regulation framework.
Non-regulated entities (they are regulated by ASIC as normal companies) include:
- Wholesale funders, mostly securitisers, who provide data on a voluntary basis to the RBA.
- Discretionary Mutual Funds (DMFs), who report their financial status to APRA.
- General insurance intermediaries are required to provide data to APRA.
- Registered Finance Corporation (RFC), who are required to make financial reports to APRA, a list of entities is here. RFC’s include activities as diverse as motor vehicle finance, consumer finance, equipment leasing, and a range of investment banking activities.
One other sector to consider is the growing number of self-managed superannuation funds, which is regulated by the ATO, worth about $506bn.
The RBA argues that all prudentially regulated assets, and self-managed super should not be included in the shadow banking bucket. As a result, the data for the two categories can be shown as follows:
The smaller shadow banking sector in Australia therefore looks like this:
So today, shadow banking, on these definitions has ~$500bn of assets, whereas the regulated sector (including self-managed super) is ten times larger.
Looking at the trends, prior to the GFC, we saw significant growth, especially in securitisation, this fell away after the financial crisis, as we highlighted in an earlier post. The demand for wholesale funding by non-banks was strong, until the world changed, and pricing took a hike, to the point where their business models broke. Now, deposit funding is more attractive, although we are seeing some potential recovery in non-banking securitisation more recently. Likewise, many overseas money market corporations withdrew. We have split out a number of investment funds, including public unit trusts who might invest in equities or property, cash management trusts, and hedge funds.
Another way to look at the split by investment type is illustrated by this data from the ABS, which shows how diverse the managed funds investments are. Data on cash management and unit trusts show the same trends.
The core question is to what extent do assets in these non-prudentially regulated sectors have the characteristics and risks of shadow banking? Actually it is hard to know, for example, are cash management trusts, or unlisted property or mortgage trusts linked to credit flows and risks? Probably. What about unit trusts which are invested in equities, perhaps not?
The wider question, however is the extent to which the prudentially regulated entities and the non-prudentially regulated entities are connected (either locally or globally). The data is hard to pin down. Perhaps 5% of Australian bank assets are exposed to shadow bank intermediaries, and 18% of shadow banking assets in Australia are exposed to the banks. The challenge is to better understand these connection, and begin to tease apart the links and risks.
This is the challenge, not just in Australia, but elsewhere, because the “unknown unknowns” lay here. This is why markets are nervous of the situation in China, where the shadow-banking sector is large, and its links unclear.
Locally, if we accept the regulatory definitions as presented here, the shadow banking sector appears small, mostly centered around securitisation, and is shrinking rather than growing. However, perhaps these underlying assumptions need to be tested harder, because it is likely that shadow banking will continue to evolve and the superficial clarity implied by the regulators in Australia may belie the complexity which exists below the surface. The truth is the financial complexity is the friend of the investment banker, and the more complex the structures, the less likely it is the full risks of transactions will be understood by the regulators.
The case for splitting retail banking and investment banking is based on the argument that it is impossible to mix the two and not loose sight of the risks involved. Some are calling for a new version of Glass-Steagall, the 1930s US Act which separated retail banking activities from investment banking activities, and which was cast aside as part of financial deregulation. Recent attempts to ring-fence retail activity from investment activity through the Volcker Rule in the US, or in the UK, (retail and capital market activities are being separately capitalised) are watered down responses. Bankers will argue that they need to access capital markets to manage their retail business. However, perhaps Glass-Steagall II would be the right objective response to tackling and managing shadow-banking.
Meantime, regulators around the world are spending time trying to get better data to map the status quo. Perhaps we need a more radical response?
