One of the reasons our financial system is not designed to be dependent on regulators to control systemic risk is the sheer inability of the regulators to keep pace with financial innovations.  The latest example of this is regulators worrying how they are going to regulate shadow banking.

As Reuters reports:

U.S. financial regulators are struggling to agree on how to tackle the huge network of lenders operating outside of traditional banking channels, as worries grow that the lack of oversight over this system is increasing systemic risks.

While the Federal Reserve has vowed to ramp up its efforts to rein in the risks posed by non-bank lenders, defining the sector known as “shadow banks,” and forming a strategy to regulate it continues to elude the central bank.

Shadow banking is an area where the Transparency Label Initiative™ can help the regulators.  It helps the regulators by bringing the risks these “shadow banks” take out into the open.  First, it forces the “shadow banks” to be transparent as those that remain opaque will have a much harder time attracting funding. Second, it helps with management of systemic risk.  Investors know that where there is transparency they should exercise self-discipline as they are responsible for all losses on their exposures.