Shadow Banking in Europe: Idiosyncrasies and their Implications for Regulation

This paper studies the specificities of the regulation of shadow banking in Europe. It argues that the idiosyncratic features of the EU shadow banking sector call for a different (or indigenized) regulatory approach from that of the US. It highlights striking differences between the EU and the US shadow banking sectors based on both market structure and legal micro-infrastructure of the shadow banking sectors in these two jurisdictions. These different institutional and legal infrastructures of the shadow banking activities, instruments, and entities, as well as the different trajectories in the evolution of the banking and shadow banking sectors in terms of business models, size and composition of actors and transactions can be the driving force behind the differential regulatory treatment of shadow banking in the EU and the US.
In highlighting the differences between shadow banking across the Atlantic, this paper focuses on the repo markets, as the main instruments and activities that play a significant role in credit intermediation outside the regulatory perimeter of the traditional or regular banking system. It then discusses one specific segment of the shadow banking entities, i.e., Money Market Funds (MMFs), and highlights the fundamental differences in the structure, functioning, and existing regulatory treatment of the MMFs in the US and the EU. The paper concludes that the market structure, business models, as well as legacy legal and regulatory frameworks of shadow banking (as well as banking) display substantial differences in the US and the EU. The findings in this paper rally against one-size-fits-all approaches to addressing the problems of the shadow banking system worldwide and recommends differentiated and more nuanced regulatory approaches to regulating shadow banking across the Atlantic. By implication, any adoption of the US regulatory framework or recommendations of international fora for the shadow banking sector by the EU regulatory authorities should not overlook these differences.