ECB call for more regulation of shadow banking system
The European Central Bank warned Monday that unless it and peers can regulate the shadow banking system, measures taken to ward off a financial collapse could cause banks to take greater risks in the future.
"Unless new regulations and a material extension of oversight to the new world of financial intermediation -- which the crisis has exposed -- are applied in earnest, central bank activism risks fuelling moral hazard in the long run," ECB executive board member Lorenzo Bini Smaghi said in New York.
Moral hazard refers to the situation where a bank may take on too much risk, betting that in the event of trouble it will be bailed out by government, meaning its losses are paid for by the taxpayer who has previously not enjoyed any benefits from the bank's actions.
He identified the shadow banking system as "a hybrid aggregate of institutions and functions" that has taken over the central role of managing financial transactions from depository institutions, or the commercial banks.
Central banks were forced to step in as lenders and now borrowers of last resort when interbank markets froze, first amid fear following the collapse of the US investment bank Lehman Brothers in September 2008, and more recently as a result of the eurozone debt crisis.
The ECB has begun a controversial programme of purchasing sovereign debt to maintain liquidity so that the commercial banks can get fresh funding their peers are reluctant to provide.
"Sovereign debts instruments are likely to continue playing an important role as collateral -- both in private lending and in central bank refinancing operations," Bini Smaghi said.
Central banks will have to remain "flexible enough to adapt their instruments to changes to the financial environment," but inflexible in pursuing the ultimate goal of safeguarding price stability, he added.
Bini Smaghi was speaking to the Barclays Global Inflation Conference.
© 2010 AFP