Shadow Banking Increases the Risk of Another Global Financial Crisis

Shadow Banking Increases the Risk of Another Global Financial Crisis
Just like the characters of "The Big Short," its time to pick up the warning signs of a global financial crisis. Paramount Pictures
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Banks may still be evading increased regulation by shifting activities to shadow banking. This system is well established as part of the financial sector, but it provides products that separate an investor from an investment, making it more difficult to evaluate risk and value.

This lack of transparency increases the risk in our financial system overall, making it vulnerable to the types of shocks that caused the 2008 global financial crisis. A current example is the so-called “bespoke tranche opportunity“ offered by shadow banks. This is similar to the notorious collateralized debt obligations, packages made up of thousands of mortgage loans some of which were subprime, blamed for the global financial crisis.

Shadow banking is comprised of hedge funds, private equity funds, mutual funds, pension funds and endowments, insurance and finance companies providing financial intermediation without explicit public liquidity, and credit guarantees from governments. Shadow banking is usually located in lightly regulated offshore financial centers.

In the period leading up to the global financial crisis, a large portion of financing of securitized assets that allowed regulated banks to exceed limitations on their risk-taking was handled by the shadow banking sector.

To this day, shadow banking continues to make a significant contribution to financing the real economy. For example, according to the Financial Stability Board, in 2013 shadow banking assets represented 25 percent of total financial system assets. While the average annual growth in assets of banks (2011–2014) was 5.6 percent, shadow banking growth stood at 6.3 percent.

A comparison of country-based share of shadow banking assets between 2010 and 2014 reveals the largest rise for China from 2 percent to 8 percent, while the United States maintains its dominance of the shadow banking markets with around 40 percent.

Necmi K. Avkiran
Necmi K. Avkiran
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