Watchdogs to drag shadow banks into the light

Tough new rules on capital requirements for banks -- known as Basel III -- are forcing banks to increase their safety buffers, while the U.S. "Volcker rule" bans overly risky bets by banks on financial markets.

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And opaque unlisted derivatives will have to be traded on exchanges in the future, rather than directly between banks in "over the counter" deals.

But despite these efforts, large swathes of the financial system remain outside the remit of the regulators, even though they provide essential funding to banks, and were at the heart of the global financial crisis.

This sector, known as "shadow banking" -- much to the chagrin of the people operating in it -- is huge. The size of the sector was some $60 trillion (37.98 trillion pound) in 2010, making it as big as roughly half the global banking industry.

"Shadow banking is not really well named. It would be preferable to have a better description of what is a wide range of non-bank intermediaries. As it stands, it sounds a bit pejorative," said ICAP's De Vidts.

A run on its funds is as much a real risk for a shadow bank as it is for a normal bank, regulators say, and could have devastating consequences for the global financial system because the two sectors are so closely linked.

Paul McCulley, the former PIMCO portfolio manager credited with coining the expression "shadow banking," warned as early as 2009 that the system "drove one of the biggest lending booms in history, and collapsed into one of the most crushing financial crisis we've ever seen."

Governments stood behind their banks when the interbank lending market dried up at the onset of the crisis, bailing them out with billions of dollars to protect depositors. But shadow banks would have no such fall-back option.

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Another risk identified by the Financial Stability Board (FSB)- the powerful body mandated by the G20 group of the world's richest economies to draw up new rules for shadow banking - is that they could be used to avoid financial regulation and attract risky activities that are banned elsewhere.