Shadow Banking and Securities Law

Abstract

Shadow banking may be the single greatest challenge facing financial regulation. Financial institutions that function like banks, but outside the scope of banking regulation—aptly termed “shadow banking”—were at the heart of the Global Financial Crisis and most episodes of serious financial stress since then. Scholars have largely focused on one response to this problem—extending traditional banking regulation to shadow banks. Yet more than fifteen years after the crisis, major regulatory efforts along this route have stalled.

In this Article, we explore the uneasy case for greater regulation of shadow banking through securities law. Our first contribution is analytical. We demonstrate the enormous jurisdiction already enjoyed by securities regulators over shadow banking. This fact has deep roots in the architecture of U.S. financial regulation. While banking law adopts a narrow and formalistic definition of banking, securities law does the opposite, adopting a set of open-ended, capacious, and functional definitions of its core categories—“security,” “investment company,” “dealer,” and the like—that end up encompassing almost all financial investments. As a result, securities regulators can regulate shadow banking. More importantly, we show that how shadow banking falls under securities law matters. Each status provides a distinct statutory basis that will shape the policy levers available to regulators. This will only prove more important in an era of increased judicial skepticism of agency power.

Our second contribution is to explore the promise and limits of regulating shadow banking through securities law. The core affirmative case lies in the fact that securities regulators have clear authority to act, and that shadow banking poses grave dangers to financial stability. In fact, securities regulators already address financial instability to a greater extent than is widely appreciated. The case remains uneasy, however, because the SEC’s mandate and balance sheet are limited, and there are legitimate concerns about the agency’s ability to effectively craft ex ante regulations aimed at shadow banking. Nonetheless, we argue that greater action is on balance justified. Our account has important implications for policy as well as for understanding the architecture of financial regulation.

Keywords: financial regulation, shadow banking, securities law, money market funds, repo, stablecoins, crypto banks