The so-called shadow banking sector played a big part in the financial crisis, and must be reined in by regulation, says Lord Adair Turner, chairman of the UK’s Financial Services Authority.

In a speech to the CASS Business School, Turner stresses that the crisis was not simply caused by mainstream banks, but that shadow banking activities — such as securitized lending, credit hedge funds, trading of credit securities, the issuance of asset backed commercial paper and the ‘repo’ market — played a major role too. So far, however, it’s only the mainstream banks that are facing increased regulation to enhance financial stability.

He notes that since the crisis, the world’s regulators and central banks have focused on building a more stable banking system with less leverage, more liquidity, and better supervision. “But it’s striking that the crisis did not initially seem to be one of banks themselves, but rather of an apparently new phenomenon: shadow banking. So we need to ensure that our regulatory response appropriately covers shadow banking as well as banks,” he said.

Turner argues that, while some of the particular forms which shadow banking took in the pre-crisis period have declined in importance, the underlying factors which drove shadow banking activities are still present, and unless checked by regulation, will produce instability in future.

“We need to understand shadow banking not as something parallel to but separate from the core banking system, but deeply intertwined with it. The way in which shadow banking contributed to financial instability reflected and still reflects fundamental developments in our financial system which are relevant to banks as much as to shadow banks, which remain important today and which could produce new problems in the future,” he says.

Turner also reaffirmed the determination of the Financial Stability Board to deal with shadow banking issues, and ensuring that adequate responses to the risks are put in place.

“This time we need to ensure that we are sufficiently radical,” he says. “But also not fool ourselves that any set of reforms we can now design will be sufficient to make the system permanently safe.”