THE NEED TO THROW LIGHT ON SHADOW BANKS

Non-bank institutions have profoundly altered the global financial system and pose poorly-understood risks. Yet, regulators allow them to thrive, fearing credit contraction in a borrowing-driven economy

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IN the 2008 crash, unregulated financial institutions contributed to global instability.

In the aftermath, regulators promised to control these ‘shadow banks’, which themselves prefer to be known by the less pejorative terms market-based finance or non-bank financial institutions. But it didn’t happen. Shadow banks’ share of global financial assets in 2022 was around 47 percent, up from 25 percent in 2007-08, compared to conventional banks’ 40 percent. And the phenomenon is global.

While some structures have declined or disappeared, others have prospered and new ones appeared. Today, the shadow banking complex is dominated by asset managers such as insurance companies, pension funds, non-bank financial companies, and collective investment vehicles (funds, investment companies or partnerships, hedge funds) who invest client funds in public and private equity, debt, or hybrid securities. Other examples include securitisation vehicles which repackage existing obligations into new securities. There are also specialised microloan organisations, trade financiers, asset-based lenders, payday lenders, as well as pawn shops and loan sharks. China has a particularly wide range of shadow banks providing wealth management products, trust loans, and undiscounted bank acceptance bills.

There are commonalities within these disparate operations. They intermediate capital flows between investors (retail, high-networth individuals, family offices, institutions, and sovereign funds) and businesses. They trade in financial markets using a variety of strategies. Most importantly, there is limited regulation relative to that applicable to banks, because shadow banks theoretically do not take deposits from the general public and are not part of the payments system.