What is shadow banking?
The
term “Shadow Banking was coined by McCulley
in the year 2007.Pozsar and Adrian and Shin presented articles the first articles on Shadow Banking.
The shadow banking system is similar to
the traditional banking system but the range of activities, mirror each other.
Shadow banks simply take the credit intermediation process of traditional banks
and separate it into its constituent steps. As an example, a normal process for
a bank might be to gather deposits, originate loans, package a pool of loans
into an asset-backed security, and sell the security to an investor. The same
process when occurred within the shadow banking system might require multiple
specialized firms each performing a different function.
From a risk perspective, the traditional
and shadow banking systems differ in 3 key areas.
1 .Shadow banks do not hold deposits –
Traditional banks have the benefit of being able to fund their activities using
their own deposit base. These are also insured, making them highly stable.
Since shadow banks are not depository institutions, they primarily tap
short-term wholesale funding markets.
2. Shadow banks do not have
access to deposit insurance or central bank liquidity – Since shadow banks do
not hold deposits, insurance is generally moot. However, unlike
traditional banks, if shadow banks run into funding troubles, they do not have
access to emergency lending facilities from their central banks.
3. Shadow banks are not subject to the same
degree of regulation – In compensation for deposit insurance and emergency
central bank support, traditional banks are subject to a wide variety of
regulations including minimum standards for lending, capital and liquidity
buffers, limits on leverage, and ongoing monitoring by regulators. In contrast,
shadow banks are subject to a much flexible set of rules and less monitoring,
if at all.
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