Shadow Banking: The Blind Spot in Banking and Capital Markets Reform

“Shadow banking” is the concept used by the Financial Stability Board (FSB) and the Euro- pean Commission to propose a new bout of regulatory reforms. The problem of this concept is less in its negative bias than in the fact that it mischaracterizes and marginalizes the problem. Rather than an issue of market players avoiding the rules, shadow banking’s is a story of market players exploiting the rules and institutional structures created for their benefit. Rather than a separate ‘parallel’ system, shadow banking encompasses major players and markets, and has become the system, thanks partly to policy choices. The phenomenon of shadow banking should prompt a deeper discussion about the influence of legal institutions in market structures, and the perils of artificial distinctions between ‘banking/money markets’ and ‘capital markets’. Drawing the appropriate lessons is particularly important now that momentous reforms, such as the Banking Union and Capital Markets Union, seem to go back to traditional (and unrealistic) dividing lines.