The unregulated “shadow banking” sector is facing stricter rules to help avert another financial crisis in the EU.
The industry is estimated to be worth 24 trillion euros in Europe.
Analyst Frederic Hache, from ‘Finance Watch,’ explained it how it works.
“Shadow banking is essentially a list of activities and entities that are not banks but they perform bank-like activities such as lending or raising funding with deposit-like characteristics,” he said.
“Banks rely on shadow banking for their short term funding for a significant part.
“So any shock in the shadow banking system has immediate repercussions to the traditional banking system as we have seen during the crisis.”
A draft law now being considered by EU officials would regulate the euro money market funds sector.
It would demand that some funds set aside cash buffers, to avoid a panic should many investors withdraw money all at once.
The legislation has been criticised by industry as too harsh but by Germany as not strict enough.
EU financial services chief Michel Barnier said it will reduce the threats posed to the wider financial system.
“This is not a punishment, it is about functioning normally,” he said.
“It means there must be transparency and good supervision and that the risks taken by those in this sector – in this parallel banking sector – are subject to precautions. That there is more of a guarantee when there are risks.”
The shadow banking sector is also expected to be debated at the G20 summit in St Petersburg on Friday.