ECB proposes shadow banking tax
25 August 2016 Brussels
Image: Shutterstock
The European Central Bank (ECB) has proposed the introduction of a tax on ‘shadow banking’ profits in order to check the growth of the controversial alternative financing industry.
In a 25 August working paper, ECB analysts concluded that the unrestricted growth of the shadow banking industry posed a systemic risk to the European financial system
They emphasised that the tax would serve as a deterrent to potential future entrants to the market and not a means to eliminate the sector altogether.
Therefore, the rate would float at an optimal level that “reduces the equilibrium size of the shadow banking sector to the highest level that is compatible with financial stability”, as opposed to a fixed rate which might prove fatal for the alternative market, according to the working paper.
Primarily, the ECB suggested that shadow banking activity neutralises the effectiveness of a central bank’s ability to offer quantitative easing (QE) in the case of an asset fire sale.
“We find that such an intervention [QE] is indeed effective when the size of the shadow banking sector is taken as given. However, the expectation of such asset purchases fuels further growth of the shadow banking sector in a manner that offsets the positive effects of the policy,” the ECB analysts explained.
“We find that during periods of stability such as the Great Moderation, the shadow banking sector grows to a size that makes it systemically important. A collapse of the shadow banking sector then triggers a fire-sale that leaves traditional banks vulnerable to self-fulfilling bank runs,” they continued.
In a 25 August working paper, ECB analysts concluded that the unrestricted growth of the shadow banking industry posed a systemic risk to the European financial system
They emphasised that the tax would serve as a deterrent to potential future entrants to the market and not a means to eliminate the sector altogether.
Therefore, the rate would float at an optimal level that “reduces the equilibrium size of the shadow banking sector to the highest level that is compatible with financial stability”, as opposed to a fixed rate which might prove fatal for the alternative market, according to the working paper.
Primarily, the ECB suggested that shadow banking activity neutralises the effectiveness of a central bank’s ability to offer quantitative easing (QE) in the case of an asset fire sale.
“We find that such an intervention [QE] is indeed effective when the size of the shadow banking sector is taken as given. However, the expectation of such asset purchases fuels further growth of the shadow banking sector in a manner that offsets the positive effects of the policy,” the ECB analysts explained.
“We find that during periods of stability such as the Great Moderation, the shadow banking sector grows to a size that makes it systemically important. A collapse of the shadow banking sector then triggers a fire-sale that leaves traditional banks vulnerable to self-fulfilling bank runs,” they continued.
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