Shadow Banking Development in Asia: impacts on traditional banks
By acting as a financial intermediary outside of the banking system, shadow banking has played a major role in offsetting banking system shortcomings in Asia enabling underbanked communities to access alternate credit and investment solutions with higher yields. Due to lack of regulations on shadow banking activities including simpler on-boarding procedures and favorable capital requirements, an increasing number of customers are finding value in this alternate banking system.
Shadow banking, which has been outperforming the development of traditional banking systems, represents a real threat to conventional banking as it can undermine the stability of the financial system with risks being potentially transmitted to the regulated system.
Sia Partners has analyzed the current shadow banking development in Asia including regulatory response in the region and impacts on banks, as there is a need for traditional banks to review their strategy and protect themselves from systemic risks and become more attractive to prospective clients.
Shadow Banking overview in Asia
Shadow banking size and evolution
The size of the shadow banking industry in Asia is difficult to be estimated due to lack of a clear definition of shadow banking and scope of activities included. Asian countries did not abide by a single definition of shadow banking and claimed the right to discretionary application of the global definition at local level.
Shadow banking estimations in Asia account for less than 15% of total financial system assets. Japan and China have the most developed shadow banking activities (in terms of financial assets), whereas Hong Kong and Singapore, as central financial hubs, have the largest OFI sectors relative to the size of their economies:
Favourable context and regulatory framework
Shadow banking’s success in Asia has also been attributed to the light regulative environment that it functions in. It has even been encouraged by governments as a way to support economic growth and encourage companies and private investments (e.g. in China).
Global regulatory framework evolution
Global regulatory background and turning point in Asia
Global awareness and attempts to regulate the shadow banking industry started at the November 2010 Seoul Summit, where the G20 Leaders requested FSB to develop recommendations to implement shadow banking practices.
Since then, global monitoring exercises have been put in place to control shadow banking development and Asia has been heavily involved in shadow banking monitoring since its rollout in February 2013, through the establishment of the Working Group.
All RCGA countries speak with one voice in defence of a domestic and flexible approach to shadow banking as shadow banking is considered as a complement to conventional banking as it plays a major role in filling credit void and financial inclusion.
Impact on traditional banks in Asia
Shadow banking risks
Shadow banking spill over impact on the overall financial system (systemic risk) is considered as the main threat for banks9. It is ascribed to shadow banking increased leverage and liquidity risks that have been identified by Asian countries as potential factors that may lead to the shadow banking industry collapse.
As a major impact of shadow banking development, the substitution of traditional banks by shadow banking entities led to loss of individuals as well as corporate clients, due to banks’ lower investment yield offerings and stringent on-boarding requirements.
Recommendations for conventional banks
How are banks able to face shadow banking competition?
- Implement strategies to protect banks from the interconnection of shadow banking to the banking system by lobbying with other banks to implement stringent capital regulation requirements and decreasing large exposures to non-bank counterparties.
- Increase the attractiveness of the traditional banking offerings through the enhancement of shadow banking risks and transparency of conventional banking operations (cybersecurity vs. shadow banking hacking risks), the simplification and optimization of clients’ on-boarding processes and the offering of higher returns on basic investments.
- Increase the banking savings capacity as a source of risk-free investment as banks are not able to meet the demand for savings placement in some countries: in China the gross saving rate is one of the highest in the world and banks fail to meet the population demand in terms of savings account due to stringent customer on-boarding requirements and lower yields.
As the shadow banking risks awareness is increasing, it paves the way for the traditional banks to develop their offering and ability to regain their market shares as well as the governments’ power to control of their economy, with the support of a growing global concern and regulatory requirements implementation.
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- Shadow banking assets rose up to US$75 trillion in 2013 (globally), tripling in size since 2002 (Bloomberg, Shadow Banking, March 2015)
- The term “Other Financial Intermediaries” (OFIs) has been defined as a proxy for the activities of shadow banking including the following Non-Bank Financial Intermediaries: Credit Unions and Cooperatives, Collective Investment Schemes, Money Market Funds, Finance Companies, Brokerage Companies and Structured Finance Vehicles (Global Shadow Banking Monitoring Report, Financial Stability Board, October 2014)
- Australia, China, Hong Kong, Indonesia, India, New Zealand, Japan, Cambodia, Korea, Sri Lanka, Malaysia, Philippines, Pakistan, Singapore, Thailand, and Vietnam (Financial Stability Board, Regional Consultative Group for Asia Report on Shadow Banking in Asia, August 2014)
- Financial Stability Board
- Prior to this, there was no formal regulation dedicated to shadow banking industry as existing capital requirements were expected to manage the interconnection between banking system and shadow banking systems
- Regional Consultative Group for Asia Report on Shadow Banking in Asia (led by the FSB)
- RCGA: Regional Consultative Group for Asia (Australia, China, Hong Kong, Indonesia, India, New Zealand, Japan, Cambodia, Korea, Sri Lanka, Malaysia, Philippines, Pakistan, Singapore, Thailand and Vietnam)
- Financial inclusion is the delivery of financial services at affordable costs to low-income segments of a society
- However the systemic risk is mainly considered on a national scale due to the overall focus of shadow banks on local investments (the cross-border systemic risk is neglected)
- Especially to funds, securitisation structures and other vehicles
- Above 50% of GDP (The World Bank, 2013)