March 8, 2015 / 5:38 PM / in 3 years

Bank inspectors beckon Ireland's shadow lenders into the light

DUBLIN (Reuters) - Fresh from putting the squeeze on banks to behave themselves, regulators are now scrutinizing so-called shadow banks, alternative lenders like investment funds that are doing big business out of countries such as Ireland.

The sun reflects of the windows of the International Financial Services Sector (IFSC) building in Dublin March 5, 2015. REUTERS/Cathal McNaughton

The third biggest shadow banking market in the euro zone behind Luxembourg and the Netherlands, Ireland has amassed 2.9 trillion euros of assets, according to data from the European Central Bank (ECB), by way of business-friendly laws and tax exemptions.

It’s also the euro zone’s largest center for what are known as financial vehicle corporations, holding companies for assets that investors set aside with a view to re-selling. These were used by banks during the financial crisis as a way to offload dangerously creaky U.S. subprime mortgages.

Non-bank lenders are a growing source of credit in the wake of the euro zone debt crisis, when banks cut off lending to meet strict new rules on risk and interest rates plumbed record lows. While some funds now make loans directly to businesses, most buy loans and securities from banks and companies as a way of passing on credit to them.

The ECB is not unhappy with the sector’s development and indeed wants to develop more of this U.S.-style market-based funding to reduce the zone’s reliance on banks.

But with shadow banking more than doubling to 23 trillion euros over the past decade and likely to outgrow the regular banking industry within five years at that pace, the ECB also needs to make sure that it isn’t hiding any risky practices that could destabilize the financial system.

As a result, Ireland has started to probe an area hitherto largely uncharted.

“We do have a team of economists that is looking at what I would call the regulatory perimeter - activity that is not quite in the regulatory spotlight but is in the penumbra,” said Gareth Murphy, head of markets supervision at the Irish central bank and responsible for overseeing investment funds in the country.

“We are a good way down the road in terms of understanding the challenges of mapping this area.”

SEARCHING FOR RISKS

Just defining the shadow banking industry is difficult.

Nearly half - around 44 percent - of what would be deemed shadow banks in the euro zone belong to institutions for which there is no detailed balance sheet information.

The ECB believes that a large chunk of those institutions are holding companies based in Luxembourg and the Netherlands that are unlikely to even be involved in lending.

In continuing its efforts to better define the industry, European regulators are also hoping to better trace risk between trading partners. While it may be able to quantify an entity’s assets, the accompanying risk exposure can still be hard to assess because these lenders often filter that through derivatives. They also may have links outside the euro zone to groups for which no information is available.

Yet even when financial entities are compelled to report information, problems arise.

New rules for reporting derivative trades came into effect in Europe last year with over 4.5 billion individual pieces of data collected in the first six months from February, a source with knowledge of the operation told Reuters.

But many of the data fields were returned blank, the source said, meaning regulators still don’t have enough information to make a thorough analysis.

ESMA, the regulator tasked with implementing the reporting regime for derivatives, declined to comment.

Another attempt at finding clarity is regulators’ demand since last year that European hedge fund managers report their exposures and risk profiles.

And under more new European rules, funds that lend securities or cash via repurchase agreements will have to report details of those trades from 2017.

COMPETING INTERESTS?

However, while Ireland’s central bank tries to sketch the true profile of some 7,000 funds and financial vehicle corporations already in the country, the government continues to try to attract more.

Over the years Ireland has already adapted laws and taxes to make itself a location of choice for these types of lenders, which can load up on debt with minimal amounts of equity. Now it plans to unveil a new strategy next week to raise the numbers employed by what’s known as the International Financial Services Sector (IFSC) by 10,000 over five years from 35,000 currently.

Simon Harris, the junior minister of finance who will make the announcement, rebuffs any suggestion that the presence in Ireland of “brass plate” style companies with no staff or offices, makes it a weak link in global financial stability.

“The type of stuff that we are trying to attract into this country I don’t believe there are any kind of regulatory concerns with,” said the 28 year old, Ireland’s youngest member of parliament. “We are talking about jobs with substance. We are talking about well-regulated products.”

Other Irish politicians say more needs to be done, and point to the fact that Dublin-based off-balance-sheet vehicles were a key link between Europe and the U.S. subprime crisis.

IKB, a German small-business lender became the first European bank to topple due to losses accumulated in a Dublin-listed conduit which invested in U.S. subprime mortgages. SachsenLB, another German bank, also ran aground after failing to refinance a Dublin-based structured investment vehicle.

IKB and SachsenLB were regulated in Germany and cost German taxpayers billions of euros when they fell.

Since then, banks have been forced to hold much more capital to cover risky investments. But tougher rules on what kind of lending they can undertake have encouraged money to flow into the shadow banks instead.

“The suggestion is that our regulation is a lot tighter and that is true for the banks but it is not true for the IFSC,” said Pearse Doherty, finance spokesman for Sinn Fein, Ireland’s most popular opposition party.

“We need a proper open debate about what kind of investment strategy do we want. There is no point doing this when things go belly up, if things go belly up, because that is what will happen.”

Editing by Sophie Walker

0 : 0
  • narrow-browser-and-phone
  • medium-browser-and-portrait-tablet
  • landscape-tablet
  • medium-wide-browser
  • wide-browser-and-larger
  • medium-browser-and-landscape-tablet
  • medium-wide-browser-and-larger
  • above-phone
  • portrait-tablet-and-above
  • above-portrait-tablet
  • landscape-tablet-and-above
  • landscape-tablet-and-medium-wide-browser
  • portrait-tablet-and-below
  • landscape-tablet-and-below