The number-two official at the Federal Reserve on Friday urged regulators to beware of new risks to the financial system from outside Wall Street, warning that the “shadow banking” system could generate threats to stability in the future despite new rules that have made it safer.
“Regulation is a cat and mouse game,” said Fed Vice Chairman Stanley Fischer.
Speaking at a regulatory event in Frankfurt, Germany, Fischer specifically mentioned the risks associated with asset managers, such as mutual funds or hedge funds.
Those businesses have been in the news in recent days for a conflict with regulators. This week, they asked financial regulators to spell out exactly what they can do to avoid being targeted as threats to the financial system and more heavily regulated.
Asset management is just one aspect of the so-called shadow banking system, which is a nebulous concept but is generally thought to also include some large insurance companies and the government-sponsored enterprises Fannie Mae and Freddie Mac, among other businesses.
In general, shadow banks are financial firms that are not banks whose deposits are insured by the federal government.
Fischer said Friday in remarks prepared for the conference that nonbanks account for roughly two-thirds of credit market assets.
Failure of shadow banks could bring down credit markets, threatening the financial system, Fischer warned.
In 2008, the failure and bailouts of nonbanks, such as the money market mutual fund Reserve Primary Fund and the insurer American International Group, exacerbated the financial crisis and threatened to plunge the economy into a Depression.
Because shadow banks do business with banks, Fischer noted, “a shock to the nonbank sector could in turn threaten the stability of the overall banking system — as happened in the unfolding of the Global Financial Crisis.”
Overall, shadow banking is safer than it was before the crisis thanks to the multitude of new rules written since then, in Fischer’s estimation. But that doesn’t meant that the sector is not “tamed,” he cautioned, and different risks could pop up over time.
