Shadow banking shifts to Europe

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The financial crisis focused attention on shadow banking, which had been building for decades, and some felt that regulators around the world would move to restrict such activity. But the Financial Stability Board has just released a report showing that shadow banking activity rose $41 trillion between 2002 and 2011 to about $67 trillion.

This is not illicit activity. The financial system as a whole would not function without some forms of shadow banking. It would not be wise to somehow require all lending activity to originate with traditional banks. There's an obvious role for hedge funds, private equity funds, SIVs of various stripes, money market funds and so on. What's more interesting to me is the fact that the percentage of shadow banking activity based in the U.S. has declined from 44 percent in 2005 to 35 percent in 2011, as activity shifted to the U.K. and elsewhere in Europe.

The regulatory key, in my opinion, is to take a measured approach to all facets of shadow banking. There is not a one-size fits all. There may be need to alter the market for hedge fund lending to small companies for example. But there might be a more compelling case to regulate money market funds more heavily.

Indeed, the FSB has taken a hard line on money market funds, suggesting that they provide bright line rules limiting the assets that such funds can invest in, banning them from offering investors guarantees, and requiring minimum capital reserves.

For more:
- here's an article from CNBC
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- here's an article from Dow Jones

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