BRUSSELS - The European Union is trying to strengthen oversight of "shadow banking," a sector of the financial system that holds trillions of dollars in assets but is not bound by the same rules as banks.
The EU Commission says investment vehicles such as money-market funds or hedge funds active on credit markets are welcome because they provide extra sources of financing for the economy, but they can also pose threats to long-term financial stability.
The global shadow banking sector was estimated to hold assets of about 51 trillion euros in 2011 (currently $67 trillion), or almost a third of the total financial system and half the size of bank assets, according to the latest figures available from the Financial Stability Board. About a third of the sector's assets are held by firms in the U.S. and some 45 per cent in the 28-country European Union.
Commissioner Michel Barnier, who was set to announce rules and legislation to regulate the growing sector on Wednesday in Brussels, maintains many of the funds resemble banks in their operations by taking deposits and lending money, but aren't subject to the tough oversight banks face.
The ultimate goal of the legislation, which will require approval from the EU's member states and the European Parliament, is to stabilize the financial system to make sure governments no longer have to bail out financial institutions in time of crisis.
"It's because of its size and its risk that we are interested in the shadow banking sector," an EU official said. "And we have to make sure that banking activities do not flow to less regulated parts of the financial sector."
The official spoke on condition of anonymity because the legislation was not officially announced yet.
The Commission's new set of rules specifically target money-market funds, which are an important refinancing tool for Europe's economy. The funds invest in short-term debt issued by banks, governments or companies and can have a value of up to 50 billion euros ($66 billion) each.
"They are extremely liquid and important for the economy, but an individual money market fund is a huge fund ... and therefore of huge systemic relevance," the official said.
The legislation will force the funds to hold a minimum of 10 per cent of assets maturing overnight, and 20 per cent within one week, to guarantee they have sufficient liquidity to pay back investors at any point in time. The issue is important because if a fund isn't able to pay out its investors, it has to suspend its operations, a move that — given such funds' size — can disrupt the wider financial system.
The Commission says its proposals are in line with similar recommendations drawn up by the Financial Stability Board that are due to be presented to the leaders of the world's largest economies at the G-20 summit later this week in Russia.
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