François Villeroy de Galhau: Between "shadow" banking and an
angelic vision of the market - towards a balanced development of
non-bank finance
Speech by Mr François Villeroy de Galhau, Governor of the Bank of France, at the presentation of
the 22nd Financial Stability Review, Paris, 25 April 2018.
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Ladies and Gentlemen,
I am very pleased to welcome you this morning to this presentation of the 2018 Financial Stability
Review (RSF), dedicated to non-ban k finance. Intended as a forum for dialogue and exchange,
the FSR offers leading personalities from diverse backgrounds the chanceto have an open
debate. I am delighted to see many of this year's contributors here among us this morning, and I
would like to extend my warm thanks to all the speakers: Klaas Knot, President of the Dutch
Central Bank; Philip Lane, Governor of the Central Bank of Ireland; Robert Ophèle, President of
the Autorité des marches financiers; Paul Hamill, Global Headof FICC at Citadel Securities; Yves
Perrier, CEO of Amundi; and Richard Portes, Professor of Economics at the London Business
School.
The topic we have chosen to address is far from anodyne: [slide 2] according to the Financial
Stability Board (FSB), non-bank financing totalled USD 160 trillion in 2016 [Monitoring Universe of
Non-Bank Financial Intermediation, MUNFI], up 50% relative to 2008 and accounting for close to
half of all financial assets held by financial institutions worldwide, compared with 40% in 2008.
And yet - or maybe precisely because of this - there is still much heated debate over its scope
and over what exactly it should be called. In order to better understand it, we need to rid
ourselves of two mindsets: first, one of irrational fear, as non-bank finance also enables the
financing of growth and innovation; and, in contrast, an over-idealised or "angelic" vision of the
sector, as shadow banking does indeed carry risks and regulators have a role to play in
mitigating them.
1. Overcoming our irrational fears: the benefits of market-based financing
To overcome our irrational fears of non-bank finance, the words we use to describe it matter. Is
it "shadow banking", with all the negative connotations this implies, or rather, as some regard it,
"market-based finance" or "non-bank credit intermediation"? For the title of this FSR, we have
chosen the term "non-bank finance" in its broadest sense. The work carried out by the FSB
enables us to better determine its scope: the higher measure, which is entity-based [Other
Financial Intermediaries or OFIs], puts the total at USD 99 trillion. However, those activities liable
to pose a risk to financial stability, that is "narrow shadow banking",only account for USD 45
trillion, in other words a little under 30% of total non-bank finance.
Market-based finance is still not very widespread in the euro area: [slide 3] it accounts for just
20% of total non-financial corporation debt, with the remaining 80% taking the form of bank
lending. In the United States, these proportions are reversed. We should stress here that, of the
larger euro area countries, France has the highest proportion of market-based financing, at 40%.
Non-bank financing in France totals EUR 1.748 trillion, and the leading asset manager in Europe
is a French firm, Amundi. France also has an internationally recognised regulator, in the form of
the AMF, while Paris is home to the European Securities and Markets Authority, ESMA. After
Brexit, I also have every reason to believe that a significant share of the market activities of the
largest global banks will be based in Paris.
First of all, I want to put an end to the non-debate over whether market-based financeis better
than bank-based finance and vice versa, and the misconception that the US system should be
replicated in Europe: working towards a balanced development of non-bank finance simply
means giving companies the option of diversifying their debt financing. Fun damentally, the real
debate lies elsewhere: it is about switching from debt to equity.This is crucial in advanced
economies, where growth is dependent on innovation. Equity financing is better suited to the
uncertainty and often long-term returns associated with innovative projects. The euro area is
seriously lagging behind in this respect: equity only accounts for 74% of GDP, compared with
125% in the United States. Moreover, it only makes up half of the total external financing of euro
area corporations (equity + debt), compared with three quarters in the United States.
In practice, how can we successfully diversify the sources of financing? At the national level, I am
pleased to see that the "Pacte" law drafted by the Minister for the Economy and Finance seeks
to foster long-term an d equity-based life insurance contracts - by overhauling Eurocroissance -
and encourage and simplify retirement savings, including the annuity component which has the
longest investment horizon. Moreover, one approach supported by the Banque de France is the
implementation of an ambitious European framework: [slide 4]a "Financing Union for Investment
and Innovation" to better channel the euro area's EUR 400 billion savings surplus into equity
financing and innovation. This Financing Union needsto unite and build on existing initiatives, first
and foremost the Capital Markets Union, but also the Banking Union and the Juncker Investment
Plan. It also means making concrete progress in several areas: the revision of accounting rules,
taxation and insolvency lawsin order to facilitate cross-border investment, notably in equity; the
European-wide development of long-term savings products and investment vehicles such as
venture capital funds; the completion of the Banking Union.
2. Avoiding an angelic vision: monitoring, testing, regulating
So no irrational fears in the face of the shadows; but no angelic vision either. [slide 5] A portion of
shadow banking is still overly exposed to credit, liquidity, leverage and maturity risk, and there is
significant potential for these to spread to the rest of the financial system and cause financial
instability. We discussed this issue at the IMF and G20 meetings in Washington just last week.
In my view, therefore, there are three priorities for regulators [slide 6]: monitoring, testing and
regulating. Monitoring first, thanks to the compilation of detailed data on shadow banking. The
FSB already contributes to this with its annual report on shadow banking, as does the ESRB with
its European Union shadow banking monitor. But we need to go further: we need an even more
precise picture of the sector as participants and business models can vary considerably from
one country to another, and are sometimes extremely complex. It is particularly crucial to put
together a mapping of the interconnections within the shadow banking sector and with traditional
banks and insurers.
The second priority is to be able to test for systemic risks, using appropriate tools. In order to
measure the global impact of shocks, we have a particular need for liquidity macro stress-tests
that take into account investment funds: the latter are especially vulnerable to runs, in the event
of a stock market crash for example, if they are open-ended and have no system of gates. To
achieve this, we need to develop, jointly and at a global level, a harmonised framework for
systemic stress tests: the FSB already recommended such tools in 2017, but there is a real risk
that they will remain in the exploratory phase, and that no action will be taken at the level of the
financial system.
The third and last priority is to Following the finalisation of the Basel III reform in
regulate.
December 2017, the main focus for financial regulation is no longer bank solvency, but non-bank
liquidity. We nonetheless need to avoid making two mistakes. The first would be to favour one
sector over another, be it banks or shadow banking: the existence of opportunities for regulatory
arbitrage could to lead to the transfer of capital-intensive activities to less regulated, or even
unregulated entities, which would be counterproductive. The other mistake would be to impose
banking regulation on shadow banking, as the risks are not the same; in particular, the same
capital requirements cannot be applied.
At the global level, the non-bank sector needs to be provided with microprudential and
macroprudential regulations that are tailored to its particular business model and risks. With
regard to macroprudential regulation, France is a pioneer in this field with its decision to
introduce, as of 1 July this year, a measure regarding large enterprises that also takes into
account their market debt. We shall publish details on how it will work this week. But we need to
be honest with ourselves and admit that our experience of using macroprudential tools outside
the bank sector is still very limited. One of our priorities in terms of regulation should also be to
develop liquidity management tools for investment funds, and to refine the measurement of their
leverage, two issues that, fortunately, the FSB has already identified. It is also important that we
increase the transparency of shadow banking activities. In this respect, the entry into force of the
European regulations EMIR2 and SFTR should be a considerable step forward.
As I've been talking about macroprudential measures regarding large corporations, and our
subject is financial stability, I'd like to bring you up to date on bank lending in France: lending to
the private sector - to households and businesses - is growing rapidly in France, at a rate of
close to 6% per year. At the next meeting of the High Council for Financial Stability (HCSF) in
June, we shall look at whether we need to introduce additional measures.
To sum up, we have not yet finished exploring the issue of non-bank finance and I am certain that
today's event will make a valuable contribution to the debate. I would like to pass the floor now to
Aurélia End, who will host the round table, and wish you all an excellent morning.