Publication date: May 27, 2025
Shadow Banking – Legal and Regulatory Issues
Shadow banking, or the parallel banking system, includes financial institutions and credit intermediation mechanisms that operate outside the traditional banking system. These entities, unlike commercial banks, are not subject to strict regulatory oversight, which raises numerous legal and regulatory challenges. Shadow banking performs functions similar to banking, such as accepting deposits, granting loans, or financing assets, but operates in less transparent structures.
Characteristics of shadow banking
Shadow banking entities include investment funds, hedge funds , lending companies, special investment vehicles (SPVs) and securitization institutions. They operate on financial markets, using securitization mechanisms, repo transactions or issuing debt instruments. Due to their high specialization and lack of banking supervision, these institutions may conduct activities with increased systemic risk.
Shadow banking is often associated with so-called regulatory arbitrage, which involves exploiting differences in the laws between jurisdictions to reduce operating costs and gain greater freedom of action. Another problem is the difficulty in identifying and monitoring entities conducting parallel activities.
Legal and regulatory issues
Shadow banking is developing dynamically in the financial services market , especially in situations where consumers cannot use traditional banking services. An example are loan companies that offer quick access to cash without formalities, but without deposit guarantees and appropriate supervision. The lack of legal regulations in this area can lead to an increased risk of loss of capital and consumer debt.
At the EU level, shadow banking is regulated, among others, by:
Poland lacks dedicated regulation of shadow banking. Entities operating in this area are only partially covered by the provisions of the Act on Investment Funds and the Civil Code. The body responsible for supervision of financial institutions is the Polish Financial Supervision Authority (KNF), but many entities remain outside its reach.
The role of supervisory institutions
In the context of shadow banking, supervisory institutions such as the European Banking Authority (EBA) and the European Central Bank (ECB) play an important role, monitoring systemic risks in the EU. At the national level, the KNF tries to monitor the activities of non-bank institutions, but often encounters difficulties resulting from the lack of comprehensive regulations. In practice, this means the need to cooperate with other national authorities and exchange information at the international level.
The Impact of Shadow Banking on Financial Stability
Shadow banking, due to its flexibility and lack of regulation, may pose a threat to financial stability. In crisis conditions, shadow institutions may threaten the financial liquidity of the entire market, especially when they engage in risky derivatives or repo transactions. An example of this are securitization crises, which in the past led to mass defaults.
Impact on monetary policy
Shadow banking also affects monetary policy because its activities can undermine the effectiveness of traditional monetary control tools, such as interest rates. Central banks seeking to limit the risks associated with shadow banking may encounter problems in monitoring financial activity outside the regulated sector.
Regulatory proposals
To reduce the risks associated with shadow banking activities, it is proposed to:
Summary
Shadow banking is a challenge for the financial system due to the difficulty of supervision and the lack of uniform regulations. The introduction of regulations that increase the transparency of the activities of these entities and the implementation of effective supervisory mechanisms will reduce the risk of market destabilization. Taking into account the impact of shadow banking on monetary policy and the stability of the financial system requires a more comprehensive regulatory approach at the national and EU level.
EU law:
National legal acts:
Sources: