A Comparison of the US and European Shadow Banking Systems ... · Definitions • Mculley ~ î ì ì ó : ^unlike regulated banks […], unregulated shadow banks fund themselves with

A Comparison of the US and European Shadow Banking Systems:

What Can We Learn?

Antoine Bouveret (European Securities and Markets Authority)

Outline

• Defining shadow banking

• Estimates of US and European shadow banking systems

• Main features

• Conclusion

Shadow Banking: A European Perspective

Shadow banking: a new concept?


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50

100

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350

400

2004 2005 2006 2007 2008 2009 2010 2011 2012

Securities lending ABS, ABCP, securitization Repo MMFs

Note: Number of articles referring to 'shadow banking' or 'financial stability' or 'systemic risk' and the specific

components identified above in Business and Consumer Services or Banking and Credit or Accounting and Consulting

or Insurance newspapers.

Sources: Factiva, ESMA.

A growing interest in shadow banking

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500

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800

900

2004 2005 2006 2007 2008 2009 2010 2011 2012

Google trends

Note: Search volumes in gogle for "Shadow banking". Based on weekly data indexed at 100 for the peak reached in 18

November 2012 and cumulated on a yearly basis.

Sources: Google ESMA.

A growing interest in shadow banking

Definitions

• McCulley (2007): “unlike regulated banks […], unregulated shadow banks fund themselves with un-insured commercial paper, which may or may not be backstopped by liquidity lines from real banks. Thus, the shadow banking system is particularly vulnerable to runs”

• Poszar (2008): “The network of highly levered off-balance sheet vehicles”

• Pozsar et al. (2010): “financial intermediaries that conduct maturity, credit, and liquidity transformation without access to central bank liquidity or public sector credit guarantees”

• FSB (2011): “a system of credit intermediation that involves entities and activities outside the regular banking system, and raises i) systemic risk concerns, in particular by maturity/liquidity transformation, leverage and flawed credit risk transfer, and/or ii) regulatory arbitrage concerns”


Features Objective

• Bank-like activities: liquidity, maturity and credit transformation

• Without banks safety nets: no deposit guarantee scheme, no lender of last resort

• Without banks prudential regulations such as capital requirements and Basel III NSFR and LCR

• Activities rather than entities

• Leverage

Subjective

• Regular banking system

• Systemic risk concerns

• Regulatory arbitrage

• Flawed credit risk transfer


“Behold! I have brought you a man” Mapping the SBS in practice

• Additive approach: individual components (ABCP, ABS, repo, MMF…)

• Subtractive approach: shadow banking defined as a residual (Other Financial Intermediaries as in FSB (2012) and ECB (2012))

• Activities vs entities

• Gross vs net (Pozsar et al. (2012))

Pros and cons

• Identification: – Additive approach: identification of all the

components but may miss financial innovation and the systemic part of it, backward-looking

– Subtractive approach: too encompassing (as leasing corporations part of the SBS?)

• Regulation: – Additive approach provides incentives for

regulatory arbitrage

– Subtractive approach mixes different activities

– Identified market activities to be regulated (i.e. sec. lending) or rather economic activities (liquidity transformation or collateral intermediation) linked to a market-based credit system (Mehrling (2012))?


Size of US and EU shadow banking systems


1,9

5,9

23

20 20,7

16,1 14,9 14,6

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25

ago-07 apr-08 lug-10 dic-11 set-12

Misc. approaches NY FED

US shadow banking system: "real time estimates" (USD tn)

Note: Data for August 2007: amounts outstanding of open commercial paper; April 2008: repos of broker dealers and hedge

funds, ABCP and auction rate securities and tender-option bonds, July 2010: liabilities of ABS issuers, GSEs, and MMFs,

pool of securities, repo , open commercial paper and securities lending; December 2011: liabilities of Other financial

intermediaries. Shaded areas refer to estimates of the shadow banking system which were produced significantly after the

McCulley

JPMorgan

FSB

NY FED

14,4

31,0

13,0 12,2 11,8 10,5

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10

15

20

25

30

35

dic-10 giu-11 dic-11 giu-12

OFIs approach NY FED

European shadow banking system: "real time estimates" (USD tn)

Note: Data for December 2010: amounts outstanding of ABCP and ABS, size of the repo market, liabilties of MMFs; June 2011: liabilities of Other Financial Intermediaires in the euro area . Shaded areas refer to estimates of the shadow banking system which were produced significantly after the observation date. Sources: ICMA, ECB, AFME, ESMA..

ECB

(EA only)

FSB

Bouveret

(2011)

Size and trends

• Absolute size : USD 14.6tn for the US vs 10.8tn for Europe

• While the US SBS collapsed, the European SBS remained roughly stable (-30% vs -8%)

• US as a market-based system, while in Europe, banks continue to the be the main source of credit (96% of bank liabilities vs 18%).


7000

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8500

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9500

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12500

15000

17500

20000

22500

2006 Q4

2007 Q2

2007 Q4

2008 Q2

2008 Q4

2009 Q2

2009 Q4

2010 Q2

2010 Q4

2011 Q2

2011 Q4

2012 Q2

2012 Q4

US EU USD EU (in EUR, rhs)

Size of the US and European shadow banking systems

Note: The size of the shadow banking system is proxied by the liabilities of ABS issuers , GSEs and pool securities for

the US, open commercial paper (CP), the size of the repo market , securities borrowed by broker dealers (US only) and

the liabilities of Money Market Funds (MMF), in USD tn.

Sources: Flow of Funds, ICMA, AFME, ECB, ESMA.

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

2006 Q4

2007 Q2

2007 Q4

2008 Q2

2008 Q4

2009 Q2

2009 Q4

2010 Q2

2010 Q4

2011 Q2

2011 Q4

2012 Q2

2012 Q4

US EU USD

Size of the US and European shadow banking systems, in % of bank liabilities

Note: The size of the shadow banking system is proxied by the liabilities of ABS issuers , GSEs and pool securities for

the US, open commercial paper (CP), the size of the repo market , securities borrowed by broker dealers (US only) and

the liabilities of Money Market Funds (MMF), in USD tn.

Sources: Flow of Funds, ICMA, AFME, ECB, ESMA.

Composition

• Run on short term markets (repo, CP, securities lending): share decreased from 30% to 19% (-USD 3.2tn)

• Collapse of the US ABS market partly reduced by GSEs (-2.6tn for private ABS vs +0.8tn for GSEs)

• Dramatic increase of ABS issuers in the European shadow banking system…in 2008, from 12% to 26%.

• Let’s take a closer look at securitization…


0%

10%

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90%

100%

2006 2007 2008 2009 2010 2011

ABCP Repo MMF ABS

Composition of the European shadow banking system: shift to ...ABS!

Note: The size of the shadow banking system is proxied by the liabilities of ABS issuers , open commercial paper

(CP), the size of the repo market , and the liabilities of Money Market Funds (MMF), in % of total.

Sources: ECB, ICMA, FAME, ESMA.

0%

10%

20%

30%

40%

50%

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70%

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100%

2006 2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012

ABS, GSEs MMF Securities lending CP Repo

Composition of the US shadow banking system: shift to MMFs and GSEs

Note: The size of the shadow banking system is proxied by the liabilities of ABS issuers , GSEs and pool

securities for the US, open commercial paper (CP), the size of the repo market , securities borrowed by broker

dealers (US only) and the liabilities of Money Market Funds (MMF), in % of total.

Securitization and ratings

• Number of ratings burgeoned in 2005-2007 along with activity.

• US ABS: USD 7tn outs. in 2007, and RMBS ratings amounted to ~70500.

• Collapse in new ratings in 2008.

• Similar trends in Europe, but smaller in size.

• EU ABS: USD 3.2tn outs. in 2007, with ~3100 RMBS ratings.


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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Outstanding ratings New ratings (rhs)

Ratings of US RMBS (S&P)

Note: Number of ratings for US RMBS,.

Sources: CEREP, ESMA.

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Outstanding ratings New ratings (rhs)

Ratings of European RMBS (S&P)

Note: Number of ratings for European RMBS,.


The rise and fall

• In 2006, 93% of US RMBS (2006 vintage) were investment grade and 50% were AAA.


• 5Y later, around 50% defaulted and only 4% remained investment-grade, among which 1% were AAA.

50%

15% 13% 14%

7%

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AAA AA A BBB <BBB

Credit ratings of US RMBS (2006 vintage, ratings as of end-2006)

Note: S&P Credit ratings of US RMBS for the 2006 vintage.


1% 1% 1% 1%

31%

47%

18%

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60%

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5000

AAA AA A BBB <BBB default withdrawal

Credit ratings of US RMBS (2006 vintage, ratings as of end-2011)

Note: S&P Credit ratings of US RMBS for the 2006 vintage.


The rise and fall

• In Europe, 92% of RMBS were investment grade, and 42% AAA.


• 5Y later, around 50% defaulted and only 4% remained investment-grade, among which 1% were AAA.

6%

14% 16%

8%

20%

0%

36%

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140

AAA AA A BBB <BBB default withdrawal

Credit ratings of European RMBS (2006 vintage, ratings as of end-2011)

Note: S&P Credit ratings of European RMBS for the 2006 vintage.


42%

15% 16% 18%

8%

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10%

20%

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40%

50%

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120

140

AAA AA A BBB <BBB

Credit ratings of European RMBS (2006 vintage, ratings as of end-2006)

Note: S&P Credit ratings of European RMBS for the 2006 vintage.


The role of institutions

• In the US, the ABCP and ABS market collapsed, despite policy action (FED’s alphabet soup)

• GSEs provided some support during the crisis, but also incentives for the expansion of the SBS before the crisis.


• In Europe, issuance of ABS peaked during the crisis.

• What were the drivers?

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4500

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6500

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8500

Q4 2006

Q2 2007

Q4 2007

Q2 2008

Q4 2008

Q2 2009

Q4 2009

Q2 2010

Q4 2010

Q2 2011

Q4 2011

Q2 2012

ABS GSEs CP (rhs)

Collapse of the US ABCP and ABS market, support from GSEs

Note: Liabilities of ABS issuers ,GSEs are computed as liabilities of GSEs and GSEs pool securities, open

commercial paper (CP), in USD bn.

Sources: Flow of Funds, ESMA.

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800

2004 2005 2006 2007 2008 2009 2010 2011 2012Q2

ABS issuance

ABS issuance peaked in 2008 in Europe

Note: Issuance of ABS, in EUR bn.

Sources: AFME, JPMorgan, ESMA.

The role of institutions

• Unlike FED and BoE, ECB monetary policy framework allowed for a wide range of collateral to be used for repo.

• Almost all ABS issued in 2008 were retained by the issuer…

• … to be used as collateral for ECB refi operations

• ECB provided liquidity backstops to ABS issuers (banks)=public safety net


47%

99% 98%

79% 76%

67%

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100%

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2007 2008 2009 2010 2011 2012Q2

Placed Retained retained in % of issuance (rhs)

ABS issuance peaked in 2008 in Europe

Note: Issuance of ABS, in EUR bn.

Sources: AFME, JPMorgan, ESMA.

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2004 2005 2006 2007 2008 2009 2010 2011 2012Q2 ABS posted at the ECB ABS eligible ABS used in % of eligible ABS (rhs) ABS in % of collateral posted at the ECB (rhs)

ABS as collateral used for ECB refinancing operations

Note: EUR bn.

Sources: ECB, ESMA.

Interconnectedness 07-08

• European institutions were exposed to the US shadow banking system, as issuers of US ABS and MBS…

• …and main issuers of ABCP in USD.


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2000 2001 2002 2003 2004 2005 2006 2007 2008

ABS issuance In % of all US issuance (rhs)

US ABS and RMBS issuance perfomed by European institutions

Note: Issuance of ABS, in USD bn.

Sources: Dealogic, ESMA.

Country/Area USD In %

Europe 388 55%

Germany 139 20%

UK 92 13%

NL 56 8%

FR 51 7%

US 302 42%

ABCP sponsor location, 2007 (Shin, 2012)

Interconnectedness 11-12

• European banks get USD funding from US MMFs

• ‘Run’ on European banks from US MMFs, which cut their exposures by 90% on French banks between May-11 and June-12, resulting in a shortage of USD funding (100bn).

• Liquidity backstops provided by Central banks through dollar swaps.


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Feb-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12

Euro area banks French banks

US MMFs exposure to European banks

Note: Exposures of US 10 largest Money Market Funds to European banks, through repos, CD and CP, in USD

bn.

Sources: Fitch, ESMA.

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Feb-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12

Euro area banks EURUSD Basis swap 1Y (rhs)

US MMFs exposure to European banks

Note: Exposures of US 10 largest Money Market Funds to European banks, through repos, CD and CP, in USD

bn.

Sources: Fitch, Thomson Reuters Datastream, ESMA.

Conclusions

• Differences between US and European shadow banking systems partly linked to the institutional framework and the structure of the economy

• The European shadow banking system did not collapse...

• ...but due to interconnectedness, European banks spread the crisis to European financial markets.

• Monitoring the shadow banking system on a regional/domestic basis is necessary but not sufficient to grasp the structure of the system (more than just an addition!).

• Looking forward: role of the implementation of new regulations (Dodd-Frank vs EMIR on OTC derivatives) and differences in domestic regulations (ex: CNAV vs VNAV for MMFs).


Documents

A Comparison of the US and European Shadow Banking Systems ... · Definitions • Mculley ~ î ì ì ó : ^unlike regulated banks […], unregulated shadow banks fund themselves with