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LONDON (Reuters) - European Commission proposals due to be published on Thursday on how to fund long-term investments to boost Europe's economies brings the start of a rehabilitation for the image of "shadow banking", the largely unregulated market-based provision of credit which lay at the heart of the financial crisis.
The EC plans envisage engineering a fundamental shift in how the continent raises money for investment in infrastructure like roads and technology while at the same time moving away from an over-reliance on banks for fuelling growth in the economy.
A core element involves reviving securitization or the bundling of loans into interest-bearing bonds, a market which was fatally wounded by its central role in the financial crisis seven years ago when bonds which packaged up subprime U.S. home loans became untradeable.
Now the market for asset backed securities, currently has 650-700 billion euros worth of bonds in circulation, half its pre-crisis size.
This shrinkage, coupled with banks being wary of lending as they rebuild their capital buffers, makes it harder than ever to seed economic growth in Europe.
In the immediate aftermath of the financial crisis regulators called for a tough crackdown on the $71 trillion global shadow banking sector that also includes debt market repurchase agreements, securities lending, money market investment funds and some hedge funds.
But with the worst of the crisis now over, government attention has turned to growth and with it the regulatory mood music has also changed.
Policymakers are thinking twice about imposing new rules on one of the few sources of funding that can plug a gap left by retreating banks and the EU plans are a major milestone in this change of tack.
"It's a sign that regulators believe one aspect of shadow banking - securitization - is something to be encouraged and not discouraged, but they need to foster private sector involvement," said David Covey, head of strategy for European asset-backed securities at Nomura bank.
Last week a top regulator said efforts by global supervisors to revive securitization will be intensified with proposals due soon, a step welcomed by bankers who say clarity on rules is key to encouraging investors to return to the market.
"If there is regulatory uncertainty, it's very damaging," Covey said.
The EC estimates that a trillion euros is needed in long term finance for transport, energy and telecoms up to 2020 to boost competitiveness and jobs and hopes that by encouraging market-based financing it can reduce the continent's reliance on banks for raising up to 70 percent of funds for the economy.
Some European policymakers look to the United States, where markets instead fund about 70 percent of the economy, as a model to emulate.
"There is no single action or 'magic bullet' which will revolutionize the financing landscape in one go; rather a range of different responses is required in parallel," the EC said in a draft of the proposals seen by Reuters last month.
The European Commission will also publish a separate set of action points to help foster the still tiny crowdfunding sector and fund more start-up businesses.
Shadow banking may also get a boost in other ways this week when the 11 euro zone countries that have pledged to reach a deal by May on taxing financial transactions meet.
Some of the countries want to exempt two other parts of the shadow banking sector, repurchase agreements and securities lending and borrowing, from the tax, out of fear their inclusion could crimp a source of funding for the economy.
The developments in Europe come ahead of leaders of the Group of 20 economies (G20) meeting in November to endorse new rules for shadow banking. A harsh, uniform approach across all sectors has now been ruled out, a senior policymaker involved in the process said.
"Shadow banking was an amplifier but not a cause of the financial crisis and we don't want to shut it down," he said.
The G20 took tough steps to force banks to hold more capital but a more "humble, proportionate approach" is now envisaged for shadow banking, with a focus on gathering data rather than a masterplan.
"Shadow banking is likely to expand and to a large degree that is intended and a good thing. We want to preserve an open, global financial system," the policymaker added.
Editing by Greg Mahlich