World leaders set to put shadow banks on long leash

World leaders are expected to take a softly-softly approach to regulating the so-called shadow banking sector when they meet in Russia next month to avoid damaging the flow of finance to the global economy.

While governments have cracked down on risk-taking by traditional banks in the wake of the financial crisis, the shadow banking sector, an assortment of financial intermediaries that handle US$60 trillion of transactions a year - roughly the same size as the world economy - remains a source of systemic risk for taxpayers.

Such intermediaries, which include hedge funds, money market funds and structured investment vehicles, provide credit to the financial sector, but, unlike banks, have no access to central bank support or safeguards such as deposit insurance and debt guarantees.

They often rely on short-term funding sources, such as the repurchase or repo market, in which borrowers sell the lender a security as collateral and agree to buy it back later at a set time and price.

At their meeting on September 5-6 the Group of 20 economies (G20) will endorse reforms but stop short of rushing through far-reaching changes because of the role shadow banking activities play in providing liquidity to the still fragile banking sector, according to people familiar with the G20's work.

Banks' use of off-balance-sheet vehicles to repackage and sell on US subprime mortgages kickstarted the financial crisis in 2007, but such shadow banking activity, known as securitisation, is viewed as key to helping wean banks off central bank money and fund themselves.