December 15, 2015 / 6:54 PM / 3 years ago

EU watchdog tells banks to set own limits on "shadow banking" links

LONDON (Reuters) - The European Banking Authority gave banks in the European Union more flexibility than anticipated in how to manage their exposure to shadow banking, in final guidelines published on Tuesday, and delayed the start date by a year to 2017.

Regulators worry that risks will shift from mainstream lenders to the more opaque “shadow banks” like money market funds, finance companies and securitization or the pooling of loans to create a security.

“Shadow banking has the potential of putting the stability of the financial system at risk,” said Isabelle Vaillant, director of regulation at the EU’s European Banking Authority.

However, changes to the EBA’s proposals issued in March reflect, in part, a desire not to strangle shadow banking as a growing alternative source of funds for the economy at a time when mainstream banks are reining in lending in the face of tougher regulation.

Under the new regulations, exposures to shadow banking worth more than 0.25 percent of a bank’s capital must be added up and be subject to risk controls and oversight by management.

EBA said a study it conducted found that only 3 percent of exposures were above this threshold, meaning the vast majority will be excluded to ease the reporting burden on banks.

Banks will set their own limits on total exposure and exposure to individual shadow banking entities.

There had been industry concern that EBA would set a low, fixed cap, but the watchdog said shadow banks can play a role in funding the economy which it did not want to excessively limit.

The EU has just launched its capital markets union project to encourage more funding from shadow banking sectors like securitization as traditional banks have reined in lending as they curb risk-taking in the face of tougher regulation.

Banks that cannot quantify their exposures to shadow banks adequately, must comply with a “fallback approach” with a limit to 25 percent of their capital.

The guidelines will, however, help the EU’s executive, the European Commission, decide if caps on links to shadow banks are needed, EBA said.

The watchdog found that a quarter of exposures over the 0.25 percent threshold were in securitization, and a quarter in hedge funds, real estate funds and fixed income funds.

Remaining exposures included money market funds, finance companies, credit insurers, and broker-dealers.

Total shadow banking exposures above the 0.25 percent threshold in the EU totaled 567 billion euros.

Banks in Britain have the highest aggregate exposures to shadow banking groups, 285 billion euros after exposures below the threshold are stripped out. Germany has the second largest at 113 billion euros.

Using a broader definition of shadow banks than the one used in the guidelines, EBA said total banks’ exposure to shadow banks is just over a trillion euros across the EU. For the big lenders, this represents on average 45 percent of their capital.

Editing by Susan Fenton

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