The growth in hedge funds, private equity firms and other entities outside the regular banking system is leading one global group to call for stricter oversight of non-bank entities.
The so-called shadow banking system grew to $67 trillion worldwide last year, or about half the size of assets held by the banking system, according to a report released Sunday by the Financial Stability Board, an international policy body.
The U.S. has the largest shadow banking system, with assets of $23 trillion, followed by the European Union, with $22 trillion, and Britain, which has assets of $9 trillion.
A rise in shadow banking in both European Union and the U.K. has mirrored a decline in the U.S. share, to 35% in 2011 from 44% in 2005.
According to the report, banks and shadow banks have tight ties, with banks providing guarantees and credit that lower the cost of transactions and provide liquidity for non-bank firms. Developments in the shadow banking system can affect banks, and vice versa, significantly, the report found.
"The FSB is of the view that the authorities' approach to shadow banking has to be a targeted one," the group wrote in its recommendations. "The objective is to ensure that shadow banking is subject to appropriate oversight and regulation to address bank-like risks to financial stability emerging outside the regular banking system while not inhibiting sustainable non-bank financing models that do not pose such risks."
According to the board, oversight in five areas can lessen systemic risks posed by shadow banking: lessening the spillover effect between the regular banking system and the shadow banking system, reducing the susceptibility of money market funds to runs, easing systemic risks posed by other shadow banking entities, and addressing incentives associated with both securitization and secured financing contracts that may worsen strains during financial panics.
Though the relative size, composition and growth of shadow banks vary considerably worldwide, the size of the shadow banking system remains large relative to the regular banking system in the U.S., the report found.
Investment funds make up the largest slice of the shadow banking system, with $19 trillion of assets, followed by structured finance vehicles, which hold about $5 trillion of assets. Broker-dealers, finance companies, financial holding companies and money market funds each hold around $4 trillion of assets.
Overall the report measured shadow banking in 25 jurisdictions and the European Union, and across entities that make up roughly 90% of the global financial system.