Shadow banking refers to the system of credit intermediation that involves entities and activities outside the regular banking system. Although the shadow banking industry plays an important role in financing the economy, its operation outside of traditional banking regulations raises concerns over the risks it poses to the financial system. 

The shadow banking sector requires regulation because of its size (25-30% of the total financial system), its close links to the regulated financial sector and the systemic risks that it poses. There is also a need to prevent the shadow banking system being used for regulatory arbitrage.

Since the financial crisis began in 2007-2008, the Commission has undertaken a comprehensive reform of the financial services sector in Europe. However, the benefits achieved by the new rules could be diminished by risks moving to less regulated sectors.

Communication on shadow banking

The Commission issued a communication on September 2013 setting out its roadmap to limit the emergence of risks in the shadow banking sector, in particular risks of a systemic nature. These risks include a possible contagion through the connection of shadow banking activities with the regular banking system.

This communication was adopted as a follow up to a green paper on shadow banking, where stakeholders provided input to a consultation.

Proposal on money market funds

One of the actions recommended by the communication was a proposal for money market funds (MMFs), which are mutual funds that invest in short-term debt such as money market instruments issued by banks, governments or corporations.

Regulation on security financing transactions

Securities financing transactions (SFTs) were identified in the Commission communication on shadow banking as requiring better monitoring. SFTs are any transaction in which securities are used as collateral for a cash transaction. SFTs allow market participants to access secured funding and are an essential funding tool in the European Union. 

In November 2015, the European Commission adopted a regulation on the transparency of securities financing transactions (SFTR). These rules add transparency, reporting and disclosure conditions for institutions engaged in SFTs, making it easier to monitor and assess the risks involved in these transactions.