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Shadow Banking in the Americas

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The Handbook of Global Shadow Banking, Volume II

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Abstract

The shadow banking industries in the Americas are examined in this chapter. The focus is on the variety of characteristics, the role of the offshore Caribbean financial centers and the link of the national shadow banking segments with their national traditional banking industries. Special attention is given to Canada, which wasn’t badly hit by the 2007–2009 crisis but has since then shown signs of convergence with how other mature shadow banking industries have evolved and are evolving.

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Notes

  1. 1.

    To be precise, the FSB Regional Consultative Group for the Americas (RCGA) within the FSB.

  2. 2.

    See in detail: FSB, (2014), FSB Regional Consultative Group for the Americas. Report on Shadow Banking in the Americas; also, infra in this chapter.

  3. 3.

    FSB, (2014), Global Shadow Banking Monitoring Report, p. 41.

  4. 4.

    FSB, (2014), Global Shadow Banking Monitoring Report, p. 42.

  5. 5.

    FSB, (2014), Global Shadow Banking Monitoring Report, Exhibit A5–1, p. 43.

  6. 6.

    FSB, (2014), Global Shadow Banking Monitoring Report, pp. 44–45.

  7. 7.

    FSB, (2014), Global Shadow Banking Monitoring Report, p. 44.

  8. 8.

    IMF, (2007), Concept of Offshore Financial Centers: In Search of an Operational Definition, IMF Working Paper, Washington.

  9. 9.

    FSB, (2014), FSB Regional Consultative Group for the Americas. Report on Shadow Banking in the Americas, pp. 3–4. Other adjustments were made to the global template; see for details: pp. 4–5.

  10. 10.

    For further details, see FSB, (2014), FSB Regional Consultative Group for the Americas. Report on Shadow Banking in the Americas, pp. 7–9.

  11. 11.

    See for a nice write-up of the evolution and status quo of the Colombian shadow banking segment: P. Cardozo and H. Vargas, (2015), Changes in Colombian Financial Markets over the Past Decade, in BCBS, (2015), What Do New Forms of Finance Mean for Central Banks, pp. 113–135; The shadow banking (SB) in Colombia has not grown faster than the traditional financial sector. However, it plays an important role with regard to bank funding. Assets amounted to USD 31 billion, equivalent to 14% of traditional financial sector assets and 8.5% of GDP (2013). Money market funds (MMFs) represent most of the activities conducted by SB entities in Colombia (65% of total assets). It may be concluded that MMFs concentrate the most important systemic risks, given their size and connection to the traditional financial system. In 2013, their total assets were equivalent to 4.6% of GDP, while their assets and liabilities with credit institutions accounted for 80% of their total assets. Their holdings of bank liabilities amounted to 8% of bank deposits in the same year. The share of illiquid assets in the total assets of MMFs is close to 60%, far higher than the same figure for US MMFs (40%). Nonfinancial cooperatives also involve risks that are non-negligible. The assets of such entities, which comprise mostly loans, represented 2.1% of GDP in 2013. Hence, nonliquid assets and assets with maturities longer than one year amounted to 95% and 75%, respectively, of their total assets. Nonfinancial cooperatives do not have access to central bank open market operations or lender of last resort (LOLR) facilities, although their liabilities are partially guaranteed by a special deposit insurance fund. New regulation was enacted to deal with vulnerabilities in the repo market and with the liquidity risk of broker-dealers and money market funds. Regarding repo markets, first, the set of assets allowed as collateral was (more) restrictively defined. Second, rules that had been issued previously by the Colombian Stock Exchange (BVC) were included in a government decree, as a public regulation. Those rules set limits on transactions conducted on behalf of clients. In addition, exposures to transactions by an individual and to a single asset were restricted to 30% and 100% of the broker-dealer’s equity. Furthermore, an aggregate limit on the level of outstanding repos on a particular stock was established at 25% of the floating value of the stock. In a related area, haircuts were established as mandatory for sell/buy-backs to cover the market risk of the underlying asset. New regulation was also enacted to deal with the liquidity risk of broker-dealers and MMFs (for details, see pp. 119–120).

  12. 12.

    FSB, (2014), FSB Regional Consultative Group for the Americas. Report on Shadow Banking in the Americas, pp. 9–13.

  13. 13.

    See in detail on the position of broker-dealers in Colombia: FSB, (2014), FSB Regional Consultative Group for the Americas. Report on Shadow Banking in the Americas, p. 27.

  14. 14.

    FSB, (2014), FSB Regional Consultative Group for the Americas. Report on Shadow Banking in the Americas, p. 14.

  15. 15.

    See in detail: FSB, (2015), FSB Regional Consultative Group for the Americas Working Group on Shadow Banking, Second Report, October 9, pp. 8–11.

  16. 16.

    See in detail: FSB, (2015), FSB Regional Consultative Group for the Americas Working Group on Shadow Banking, Second Report, October 9, pp. 12–16.

  17. 17.

    See in detail: FSB, (2015), FSB Regional Consultative Group for the Americas Working Group on Shadow Banking, Second Report, October 9, pp. 17–18.

  18. 18.

    See in detail: FSB, (2015), FSB Regional Consultative Group for the Americas Working Group on Shadow Banking, Second Report, October 9, pp. 17–18.

  19. 19.

    FSB, (2014), FSB Regional Consultative Group for the Americas. Report on Shadow Banking in the Americas, p. 16.

  20. 20.

    See for a review of their regulatory and supervisory status per country: FSB, (2014), FSB Regional Consultative Group for the Americas. Report on Shadow Banking in the Americas, p. 18.

  21. 21.

    See in detail: FSB, (2014), FSB Regional Consultative Group for the Americas. Report on Shadow Banking in the Americas, pp. 18–21.

  22. 22.

    R. Cifuentes, et al., (2005), Liquidity Risk and Contagion, Bank of England Working Paper Series Nr. 264.

  23. 23.

    The government is bringing the General Banking Law into Basel III compliance, following a crackdown on shadow banking institutions, EIU, (2017), Chile Financial Services, October 4, via eiu.com.

  24. 24.

    The Caribbean countries covered are the Bahamas, Barbados, Belize, the Eastern Caribbean Currency Union (ECCU) countries, Guyana, Jamaica, Suriname and Trinidad and Tobago. The ECCU consists of Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, and two British territories of Anguilla and Montserrat; the Organization of Eastern Caribbean States (OECS) consists of the ECCU countries and the British Virgin Islands.

  25. 25.

    However, in most countries the offshore and onshore banking systems are insulated and separated by ‘Chinese walls’.

  26. 26.

    S. Ogawa et al., (2013), Financial Interconnectedness and Financial Sector Reforms in the Caribbean, IMF Working Paper Series, Nr. WP/13/175.

  27. 27.

    Ogawa et al., (2013), ibid., p. 9.

  28. 28.

    See for an overview Ogawa et al., (2013), ibid., p. 9, and a quantification of the financial sector interconnectedness in the region pp. 9–19.

  29. 29.

    Ogawa et al., (2013), ibid., p. 26.

  30. 30.

    See also P. Watkins, (2011), Shadow Banking: Accounting for Canada’s Productivity Gap, International Journal of Productivity and Performance Management, Vol. 60, Issue 8, pp. 857–864.

  31. 31.

    See, for example, the regulation and supervision of credit union in Canada: FSB, (2015), FSB Regional Consultative Group for the Americas Working Group on Shadow Banking, Second Report, October 9, pp. 23.

  32. 32.

    For example, over 70% of government-insured mortgage securitization (about 60% of total ‘shadow banking’) is issued by the six largest banks, which also sponsor most of the outstanding asset-backed securities/asset-backed commercial paper (ABSs/ABCP; see: IMF, (2014), Canada: Financial Sector Stability Assessment, IMF Country Report Nr. 14/29, p. 10 footnote 7 and p. 31.

  33. 33.

    R. Haltom, (2013), Why Was Canada Exempt from the Financial Crisis, Economic Research, Quarter 4, pp. 22–25, in particular 24.

  34. 34.

    See for recent estimations: IMF, (2014–2019), Canada: Financial Sector Stability Assessment, IMF Country Reports, via imf.org, latest edition 24 June 2019.

  35. 35.

    See for data and details on each category: T. Gravelle, et al., (2013), Monitoring and Assessing Risks in Canada’s Shadow Banking Sector, Bank of Canada/Banque de Canada, Financial System Review, June, pp. 55–63, in particular pp. 57–61. See also: P. Chatterjee, et al., (2012), Reducing Systemic Risk: Canada’s New Central Counterparty for the Fixed-Income Market, Bank of Canada Financial System Review (June), pp. 43–49; A. Côté, (2013), Toward a Stronger Financial Market Infrastructure for Canada: Taking Stock, Remarks to the Association for Financial Professionals of Canada, Montréal, 26 March; J. Witmer, (2012), Does the Buck Stop Here? A Comparison of Withdrawals from Money Market Mutual Funds with Floating and Constant Share Prices, Bank of Canada Working Paper Nr. 2012–25.

  36. 36.

    World Bank Research, (2012), Golden Growth, G. Indermit and M. Raiser (eds.) pp. 30–33.

  37. 37.

    T. Lane, (2013), Shedding Light on Shadow Banking, Remarks by Timothy Lane Deputy Governor of the Bank of Canada CFA Society Toronto 26 June 2013 Toronto, Ontario Shedding Light on Shadow Banking.

  38. 38.

    See in detail: B.Y. Chang et al., (2016), Monitoring Shadow Banking in Canada: A Hybrid Approach, Bank of Canada Financial System Review, December, pp. 23–37.

  39. 39.

    Outflows due to fund underperformance are larger than inflows due to outperformance, and we interpret this asymmetry as evidence of redemption run risk in Canadian corporate bond mutual funds. The risk of redemption runs increases during periods of market volatility, but funds holding more liquidity can reduce this risk. R. Arora, (2018), Redemption Runs in Canadian Corporate Bond Funds?

    Staff Analytical Note 2018–21, July; R. Arora, and G. Ouellet Leblanc, (2018), How Do Canadian Corporate Bond Funds Meet Investor Redemptions? Bank of Canada Staff Analytical Note Nr. 2018–14.

  40. 40.

    (1) J. Chapman et al., (2011), Emerging from the Shadows: Market-Based Financing in Canada, Bank of Canada Financial System Review, June, pp. 29–38; (2) T. Gravelle et al., (2013), Monitoring and Assessing Risks in Canada’s Shadow Banking Sector, Bank of Canada Financial System Review, June, pp. 55–63; (3) B. Y. Chang, (2016), Monitoring Shadow Banking in Canada: A Hybrid Approach, Bank of Canada Financial System Review, December, pp. 23–37.

  41. 41.

    G. Bédard-Pagé, (2019), Non-Bank Financial Intermediation in Canada: An Update, Bank of Canada Staff Discussion Paper Nr. 2, January.

  42. 42.

    See for a write-up of the evolution and status G. Bédard-Pagé, (2019), ibid., p. 3 ff.

  43. 43.

    G. Bédard-Pagé, (2019), ibid., pp. 9–13.

  44. 44.

    G. Bédard-Pagé, (2019), ibid., p. 14.

  45. 45.

    See for a reference to the newly used methodology: FSB, (2015), FSB Regional Consultative Group for the Americas Working Group on Shadow Banking, Second Report, October 9, pp. 7–8.

  46. 46.

    See in very much detail: FSB, (2015), Shadow Banking Monitoring Report 2015, November 12, pp. 53–56 and FSB, (2015), FSB Regional Consultative Group for the Americas Working Group on Shadow Banking, Second Report, October 9.

  47. 47.

    A full overview of the types of funds reported by each jurisdiction can be found in Annex 4 of FSB/RCGA, (2017), Working Group on Shadow Banking, Third Report, May 10, pp. 57–60.

  48. 48.

    See FSB, (2017), Global Shadow Banking Monitoring Report 2016, May 10, Annex 8, pp. 91–94; FSB/RCGA, (2017), Working Group on Shadow Banking, Third Report, May 10; FSB/RCGA, (2018), Working Group on Shadow Banking, Fourth Report, March 5. For an interim evaluation: FSB, (2018), FSB RCG (Regional Consultative Group) for the Americas assesses financial market developments and discusses effects of reforms, FinTech and crypto-assets, December 6.

  49. 49.

    Often the distinction is made between the onshore MUNFI and the offshore MUNFI sector, the latter growing the fastest.

  50. 50.

    Let’s say that offshore shadow banking in narrow terms is way more material than onshore in the Americas.

  51. 51.

    The criteria used to be considered part of the narrow OFI/shadow banking definition are as follows: (1) being a part of a credit intermediation chain; (2) not being fully (in all aspects of regulation) consolidated into a banking group for the purposes of prudential regulation; (3) exhibiting risks associated with SB including (but not limited to) maturity and liquidity transformation, and/or leverage. All three criteria need to be met. See in detail: FSB/RCGA, (2017), Working Group on Shadow Banking, Third Report, May 10, pp. 22–25.

  52. 52.

    See in detail: FSB/RCGA, (2018), Working Group on Shadow Banking, Third Report, May 10, pp. 17–21. The economic function (EF) 1 (management of collective investment vehicles with features that make them susceptible to runs) is the largest across the region followed by economic function 3 (intermediation of market activities that is dependent on short-term funding or on secured funding of client assets). Securitization-based credit intermediation and funding of financial entities (EF 5) only ranks third but shows strong growth in countries like Uruguay and the Cayman Islands.

  53. 53.

    For 2016 that holds true except for broker-dealers.

  54. 54.

    FSB/RCGA, (2018), Working Group on Shadow Banking, Fourth Report, March 5, pp. 12–13.

  55. 55.

    IMF, (2018), Brazil, Financial Sector Assessment Program, Technical Note on Stress Testing and Systemic Risk Analysis, IMF Country Report Nr. 18/344, November p. 111; BCB, (2018), Banco Central Do Brazil Financial Stability Report, Vol. 17, Nr. 1, April, pp. 40–45.

  56. 56.

    Starting in their fourth annual report, they specified their questionnaire when it comes to finance companies. This resulted in a number of new findings: (1) finance companies account for relatively large shares of OFI assets in a number of Latam countries (10–24% of OFI assets [2016]), although in absolute term the US and Canada are dominant; (2) a significant portion of finance company assets are lending assets (> 70%) with the minor part being leasing companies; (3) maturity transformation and leverage is in general low to moderate; and (4) regulatory restrictions regarding liquidity and leverage are very limited: FSB/RCGA, (2018), Working Group on Shadow Banking, Fourth Report, March 5, pp. 4–5 & 21–26. The particular interest in finance companies is driven by potential vulnerabilities, which are identified as: ‘households may build up leverage through borrowing from finance companies; there may be risks arising from interconnections with the banking section, whether through direct exposures of banks holding credit in their loan portfolio, or competition between finance companies and banks leading to credit being offered to more risky borrowers’ (FSB/RCGA, [2018], ibid., p. 21). Also, the fact that types of entities and regulation across countries are highly heterogenic adds to the structural opaqueness of the segment.

  57. 57.

    2016 data.

  58. 58.

    2016 data.

  59. 59.

    See for an overview of the asset concentration limits in the region: FSB/RCGA, (2017), Working Group on Shadow Banking, Third Report, May 10, pp. 36–37.

  60. 60.

    See for details: FSB/RCGA, (2018), Working Group on Shadow Banking, Fourth Report, March 5, p. 9.

  61. 61.

    See for details: FSB/RCGA, (2018), Working Group on Shadow Banking, Fourth Report, March 5, pp. 13–14.

  62. 62.

    The Bahamas and Barbados data are not included. See for Trinidad and Tobago: Central bank of Trinidad and Tobago, (2017), Financial Stability Report, Shadow banking and Systemic Risk, Box 3, p. 34.

  63. 63.

    Special license banks can often take no deposits from residents and limit the activities that these banks can conduct in local markets to conducting business with other licensees. In other countries, both domestic and international clients are served unsegregated (e.g. Bermuda).

  64. 64.

    See for an overview of the limits on investments in illiquid assets: FSB/RCGA, (2017), Working Group on Shadow Banking, Third Report, May 10, p. 32.

  65. 65.

    A prime example is the fact that non-MMF open-ended funds may invest not more than 15% of their net assets in illiquid assets. MMFs may invest no more than 5% of their total assets in illiquid securities. This is based on ‘Investment Company Liquidity Risk Management Programs’, Investment Company Act Release No. 32315 (13 October 2016) via www.sec.gov. The rule is applicable as of 1 December 2018 and 1 June 1 2019 for the smaller funds (< USD 1 billion). MMFs are subject to the 2a-7 rule under the Investment Company Act of 1940 and will continue to do so. See for a full overview of the limits on investment in illiquid assets: FSB/RCGA, (2017), Working Group on Shadow Banking, Third Report, May 10, p. 33.

  66. 66.

    See for a full overview of the liquidity buffers in the region: FSB/RCGA, (2017), Working Group on Shadow Banking, Third Report, May 10, p. 33.

  67. 67.

    See in detail: FSB/RCGA, (2017), Working Group on Shadow Banking, Third Report, May 10, pp. 37–39.

  68. 68.

    See for details: FSB/RCGA, (2017), ibid., p. 41: Types of leverage include regulatory, balance sheet, synthetic and market-led. Regulatory leverage is a restriction on debt or borrowing imposed by a regulator. Balance sheet leverage refers to the borrowing of money from other market participants. Synthetic leverage is leverage acquired through the use of financial instruments, such as options, futures, forwards, swaps and other types of derivatives. Market-led leverage (often called embedded leverage) refers to a position where the amount of market exposure per unit of committed capital is leveraged against financial institutions that face regulatory capital constraints.

  69. 69.

    FSB/RCGA, (2017), Working Group on Shadow Banking, Third Report, May 10, pp. 41–44.

  70. 70.

    Debt or equity instruments.

  71. 71.

    See for details and visualizations: FSB/RCGA, (2018), Working Group on Shadow Banking, Fourth Report, March 5, pp. 30–31.

  72. 72.

    The word ‘client’ can be replaced by the word ‘sponsor’ in case the structure is designed to operate intragroup.

  73. 73.

    Ultimately the SPI is subject to regulatory overview in this matter. The trust itself might qualify as a private vehicle subject to more common financial regulation or might even be in a regulatory light position. That leaves quite some discretion on behalf of the trustee to invest according to his or her insight.

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Nijs, L. (2020). Shadow Banking in the Americas. In: The Handbook of Global Shadow Banking, Volume II. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-34817-5_4

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