Shadow Banking
Shadow banking is credit intermediation carried out by institutions and markets outside the regular banking system: money market funds, finance companies, hedge funds, securitisation vehicles and repo markets doing what banks do without bank licences, deposit insurance or central bank backing.
Also called: shadow bank · shadow banks · shadow banking system · non-bank financial intermediation · NBFI · market-based finance
A bank borrows short from depositors and lends long to borrowers. The shadow system performs the same maturity transformation in pieces. One entity originates loans, another packages them into securities, a third funds the securities by borrowing overnight in the repo market, and the cash comes from money market funds whose investors treat their shares like deposits.
Regulators now prefer the term non-bank financial intermediation, and the sector holds close to half of global financial assets. It supplies real credit and competition. Its weakness is that it has run-prone funding without the protections that stop a bank run. In 2008 the run happened in repo and money funds, and central banks had to backstop markets they did not supervise.
The question is being asked again of fiat-backed stablecoins, which take in money redeemable at par and invest it in short-term assets, much as a money market fund does. Payment and e-money firms sit close to the same boundary whenever they hold customer funds, which is the reason safeguarding rules exist.
In practice
Shadow banking is a description, not an accusation. Most of the activity is lawful and regulated in some form; the point is that it is regulated differently from banks.
Commonly confused with
| Term | How it differs |
|---|---|
| Banking-as-a-service | Banking-as-a-service distributes a licensed bank's products through non-bank brands. Shadow banking performs bank-like intermediation with no bank behind it. |
See also
- Maturity TransformationMaturity transformation is the practice of funding long-term, illiquid assets with short-term liabilities that can be withdrawn or must be renewed quickly. It is the core economic function of banking and the source of its fragility.
- Bank RunA bank run is a rush by depositors or other short-term creditors to withdraw their money from an institution because they fear it will fail. Because no bank holds enough liquid assets to repay everyone at once, the rush itself can cause the failure.
- Repurchase AgreementA repurchase agreement, or repo, is a short-term loan structured as a sale: one party sells securities for cash and agrees to buy them back later at a slightly higher price. The securities are the collateral and the price difference is the interest.
- Money Market FundA money market fund (MMF) is an investment fund that holds short-term, high-quality debt such as Treasury bills, repo and commercial paper, and aims to keep a stable value while offering daily access. Investors use it like a deposit, but it is not one.
- HaircutA haircut is the percentage by which a lender discounts the market value of collateral when deciding how much to lend against it. A 2 percent haircut means US$100 of securities supports a loan of US$98.
- StablecoinA stablecoin is a crypto-asset designed to hold a steady value against a reference, almost always a fiat currency such as the US dollar. How that steadiness is supported differs sharply from one issuer to the next, and so does what a holder can actually redeem.