5 Questions: Rauterberg and Zhang on Minimizing Risk with Securities Law in Shadow Banking

Policymakers and experts have been worried about the risks associated with shadow banks for some time now. These financial institutions, like money market mutual funds and stablecoin issuers, operate similarly to banks but without the same regulations to keep them in check. This lack of oversight can lead to instability within the financial system, which can impact all of us. While the usual focus has been on changing banking laws to address this issue, Professors Gabriel Rauterberg and Jeffery Zhang had a different idea during a chat in the Law Quad – they thought securities law could be the key.

The professors took their conversation and turned it into a new paper for the Stanford Law Review. They believe that securities regulators, who already have some authority over shadow banks, could step in more to protect against risks, even if it’s not the ideal solution. Here are their insights on the matter:

1. **How does the shadow banking sector contribute to problems of insecurity in the broader economy?**
Rauterberg points out that businesses rely on both short-term and long-term funding, with shadow banks providing a significant amount of short-term financing. When there’s a sudden pullback from these shadow banks, it can lead to instability within these institutions and create a shortage of funding for businesses. Zhang notes that the sheer size of the shadow banking industry, worth trillions, and its deep connections to the broader economy can pose real problems, particularly when there’s a lack of safeguards against issues like bank runs.

2. **Efforts to address this vulnerability have largely focused on banking law, but your paper suggests approaching the issue through securities law. How did you develop this idea?**
Zhang explains that the idea came about during a walk in 2022 when both scholars realized the divide between banking and securities experts. They wanted to explore a different perspective, which led them to consider securities law as a potential solution. Rauterberg adds that they found securities law actually grants regulators authority over aspects of shadow banking, opening up new possibilities for addressing these concerns.

3. **You mentioned that securities regulators already have some authority over shadow banking. What’s an example of that?**
Rauterberg points to broker dealer regulation as an example. While these regulations mainly focus on customer protection, they could easily extend to systemic issues within the financial sector. Additionally, money market fund regulation, crucial to shadow banking, has seen limited action from the SEC. This ambiguity leaves room for the SEC to play a more proactive role in overseeing these funds.

4. **What’s an example of the bigger reforms you advocate?**
Zhang suggests applying similar safety measures to money market funds as banks, such as mandatory capital reserves for stability. While this idea may face industry pushback, it could be a logical step towards safeguarding against risks in the shadow banking sector.

5. **The paper discusses how finding political will for these changes could be an issue. Does that become even harder with a new presidential administration?**
Rauterberg acknowledges the uncertainty surrounding regulatory changes with a new administration but believes that maintaining a reasonable and competent SEC, like in the first Trump administration, is crucial. The shift in leadership might affect the likelihood of securing the needed reforms, but the importance of reevaluating regulatory structures remains clear.

In conclusion, the researchers argue that securities law could offer a fresh perspective on managing risks within the shadow banking sector. By leveraging existing regulatory frameworks and exploring new approaches, we can take significant steps towards minimizing instability and protecting the broader economy.