The Financial Stability Board has just published in 2017 report of the evolution of the Shadow Banking System LINK1. The shadow banking system is a relatively new term, its first use is attributed to Paul McCulley of PIMCO in a speech of 2007. Perhaps the most useful definition is that of the Financial Stability Board that defines the shadow banking system as:
“A system of credit intermediation that involves entities and activities outside the regular banking system… focusing on credit intermediation that takes place in an environment where prudential regulatory standards and supervisory oversight are either not applied or are applied to a materially lesser or different degree than is the case for regular banks engaged in similar activities.”
The shadow banking system can also include the unregulated activities of regulated financial institutions such as securitization and structured investment vehicles. In effect, shadow banks are financial firms that perform similar functions and assume similar risks to banks but which operate under a much lower level of regulatory oversight. Since shadow banks operate outside the formal banking sector, they generally lack the standard safety nets, such as deposit insurance or access to lender of last resort facilities. It is important to note that the emphasis is on credit intermediation so that, for example, equity, stock and foreign exchange trading are not part of the shadow banking activities. Examples of shadow banking institutions and activities include money market funds, mortgage companies, finance companies, hedge funds, private equity, securitization, structured investment vehicles, asset backed commercial paper and the repo markets.
The shadow banking system is difficult to measure and monitor as it evolves and different countries have different regulatory regimes and financial systems. The Financial Stability Board has both broad and narrow definition for the shadow banking system Whichever definition is employed, there is no question that the size of the shadow banking system rose rapidly in the run up to the financial crisis, it then shrunk during the financial crisis and has started growing again as traditional banks have cut back on lending. The estimated size of the shadow banking sector using the narrow definitiion if now $45.2 trillion according to the FSB. The percentage shares of the 29 jurisdictions are presented below:
“A system of credit intermediation that involves entities and activities outside the regular banking system… focusing on credit intermediation that takes place in an environment where prudential regulatory standards and supervisory oversight are either not applied or are applied to a materially lesser or different degree than is the case for regular banks engaged in similar activities.”
The shadow banking system can also include the unregulated activities of regulated financial institutions such as securitization and structured investment vehicles. In effect, shadow banks are financial firms that perform similar functions and assume similar risks to banks but which operate under a much lower level of regulatory oversight. Since shadow banks operate outside the formal banking sector, they generally lack the standard safety nets, such as deposit insurance or access to lender of last resort facilities. It is important to note that the emphasis is on credit intermediation so that, for example, equity, stock and foreign exchange trading are not part of the shadow banking activities. Examples of shadow banking institutions and activities include money market funds, mortgage companies, finance companies, hedge funds, private equity, securitization, structured investment vehicles, asset backed commercial paper and the repo markets.
The shadow banking system is difficult to measure and monitor as it evolves and different countries have different regulatory regimes and financial systems. The Financial Stability Board has both broad and narrow definition for the shadow banking system Whichever definition is employed, there is no question that the size of the shadow banking system rose rapidly in the run up to the financial crisis, it then shrunk during the financial crisis and has started growing again as traditional banks have cut back on lending. The estimated size of the shadow banking sector using the narrow definitiion if now $45.2 trillion according to the FSB. The percentage shares of the 29 jurisdictions are presented below:
It should be noted that the growth of the shadow banking system is not per se a problem since intermediating credit through non-bank channels can have some advantages. For example, the shadow banking system can provide market participants and companies with an alternative source of funding and liquidity. Also some non-bank entities have specialised knowledge and expertise that can enable them to provide credit in a more optimal and cost cost-efficient manner than traditional banks. However, following the financial crisis there has been increased concern about the shadow banking sector as a source of systemic risk. This stems from the fact that non-bank entities may extend funds to riskier borrowers and have poorer risk monitoring systems in place. In addition, there is the interconnectedness of shadow banks with the regulated banking sector and the possibility that problems in shadow banks will spill over to traditional banks and vice-versa. There is also concern that greater regulation of the banking sector is merely fueling the growth of the unregulated shadow banking sector. Finally, there is concern that shadow banks can increase the amount of leverage and risks in the system as they are not required to have the same level of capital adequacy as traditional banks.
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