The so-called shadow banking sector is made up of financial intermediaries, which can take in funds, in a similar way to deposits at banks, and make investments, not unlike loans made by banks.
Allen and Overy believes such firms could fill the gap in credit provision left by banks that are shrinking and cutting lending across Europe.
But regulators fear the shadow banks may be as big a source of instability as normal banks, and so want to introduce new rules to match those in the conventional sector.
“The growing number of rules are overly complex and lack the coherent design necessary across the system to facilitate an orderly flow of credit,” said regulatory partner Etay Katz.
“This is disabling rather than enabling the flow of credit in the global financial system. In the longer term, excessive regulation could also damage areas of financial activity that are understood and manageable, giving rise to a new breed of finance that is less controllable and more unpredictable.”