Chapter 1 - What Is Shadow Banking?
This treatise draws on a number of current researchers on the shadow banking sector, i acknowledge their influences on my thinking and thank them, Melanie Fien, Zoltan Pozsar, Adrian Ashcraft
The term “shadow banking” is one that is used by banking regulators, the media and academics especially when coming up with explanations for the financial crisis of 2007-2008. It has become a rallying point for international reform efforts aimed at the unregulated nonbank financial activities which have potential to destabilize the global financial system1.However on closer examination it is apparent that not only does shadow banking subsist predominantly within the regulated banking system2, it also in another
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The Financial Crisis Inquiry Commission defined it as “bank-like financial activities that are conducted outside the traditional commercial banking system”7
Despite the fact that the name “shadow banking” is reminiscent of a sinister, unexplored sector and a “pejorative connotation”8 It is the commonly used term for credit intermediation activities that are market funded (as opposed to bank-funded). As a result of this there is a sector-wide agreement on the key characteristics of shadow banking and the key ones are credit intermediation,maturity transformation, the lack of guarantee for raised funds and the absence of explicit public sector backstops in the event of liquidity problems.9 There is disagreement on some characteristics such as Leverage and Off-balance sheet treatment. There is disagreement on leverage as a result of the fact that, while some shadow banking activities are dependent on leverage for an increase in returns, Hedge funds, banks and private equity funds also do employ leverage as a tool in business. Therefore this is not a unique characteristic. Similarly disputed is
There are various categories of banking; these include retail banking, directly dealing with small businesses and persons. Commercial and Corporate banking which offers services to medium and large businesses (Koch & MacDonald 2010). Private banking, deals with individuals, offering them one on one service. The last category is investment banking. These help clients to raise capital and often invest in financial markets. Most global banking institutions provide all these services combined. With all these institutions in existence within the same localities and offering similar services, there is a need to regulate the industry so as to protect the consumer and provide fair working environment for all banks (Du & Girma, 2011).
Now, many of these banking groups are owned by foreign investors, despite attempted safeguards. This ownership has provided investors leverage and influence over the actions of the government because the government owes an exorbitant amount to these banks (Daniel Lederman). The same argument can be made about the United States’ government. This influence can be seen across the board as many decisions now seem to favor only a select few, forgetting about the ramifications for the many.
Along with the greater profitability restrictions imposed on banks from the Dodd Frank comes the banks will for greater cost management, meaning job cuts. Already the Banks have begun laying employees off from burdening restrictions leading to this brutal method of retaining necessary capital needed for operations ("Wall Street Journal"). The bigger the bank, the greater resentment they have over this act. Their financial statements will have to retain a greater amount of compliance and transparency as well. Because of the large prominence of “shadow banking” and the concealed balance sheet elements that came along with this practice, the banks now are imposed with greater regulation to prevent these stealthy tactics of borrowing and investing. These restrictions, in my belief, will provide greater protection to the consumer but will also provoke institutions to begin innovating financial instruments to get around barriers, just as they did in the past with interstate banking and early consolidated services even before Glass-Steagalls act. The bankers oppose the act due to their cut in profits. Reduced outlets in revenue from specific revenue generating activities have been capped and larger expenses in order to comply with the new rules have also greatly cut profitability. The same notion is held with brokers. Because of the greater compliance costs served
This paper is about how did “Shadow Banking” precipitate the financial Crises. Then discusses the impacts of the crisis on the major financial institutions.
The shadow banking system became highly leveraged, and the bursting of the housing bubble set off a cycle of deleveraging in the shadow banking system, which contributed into the credit crisis. Gorton (2009) described the credit crisis as a banking panic involving the shadow banking system. Zandi (2009) emphasized how the increased securitization of home mortgage debt contributed to relaxed mortgage lending standards. Keys, Mukherjee, Seru, and Vig (2008) found that the existing securitization practices adversely affected the screening incentives of lenders. Piskorski, Seru, and Vig (2008) found that loans that were the securitized had a higher foreclosure rate than the loans held by a bank. Mian and Sufi (2008) found a close of correlation between the expansion in mortgage credit to subprime zip codes and the increase in securitization of subprime
The recent financial crisis has a huge impact on systemic Important Financial Institutions; it’s distressing effect can be felt in almost every business area and process of a bank. A fairly large literature investigates the impact of financial crisis on large, complex and interconnected banks. The great recession did affect banks in different ways, depending on the funding capability of each bank. Kapan and Minoiu (2013) find that banks that were ex ante more dependent on market funding and had lower structural liquidity reduced supply of credit more than other banks during crisis. The ability of banks to generate interest income during the financial crisis was hampered because there was a vast reduction in bank lending to individuals and
The title, firstly, directly points out the key words of the argument: ‘bank’ ? the subject of scheme, and ‘cheats’, though which the whole narrative is building on. At the beginning of the documentary, questions are raised: why did our biggest bank help wealthy clients dodge tax? These
In this essay I am going to discuss the effects of shadow banking on the recent financial crisis of 2007-8. Shadow banking was one of the major causes of the financial crisis since it was the subprime mortgages which was the first trigger of the collapse in the banking system. Through this essay I am to achieve a detailed analysis of why the shadow banking was one of the causes in the financial crisis and why was it not prevented by any regulation enforced. The basis of shadow banking system is that it occurs when financial intermediaries conduct transformation of maturity, credit and liquidity without having access to the central bank liquidity guarantees or even public sector credit. Maturity transformation: obtaining short-term funds to
Americans across the board would be in shock if the truth was revealed that the establishments that they trust their moneys to are unintentionally doing business with banks that are involves in the laundering of money or providing terrorists with funding, or possibly involves in like activities themselves. In the last few decades there has been a rigorous struggle, directed by the United States and Western European countries, to limit the occurrence of money laundering and terrorist financing by urging states to implement vigorous controls to counter such activities. It is clear that there is a long way to go before anti-money laundering and counter-terrorist financing organizations are able to stop the completed
The bank's main owner, Ramón Báez Figueroa, was accused of operating a secret “bank within the bank” by officials for more than ten years (Economist, 2003).
Housing prices in the United States rose steadily after the World War II. Although some research indicated that the financial crisis started in the US housing market, the main cause of the financial crisis between 2007 and 2009 was actually the combination of housing bubble and credit boom. The banks created so much loan that pushed the housing price to the peak. As the bank lend out a huge amount of money, the level of individual debt also rose along with the housing price. Since the debt rose faster than people’s income, people were unable to repay their loan and bank found themselves were in danger. As this showed a signal for people, people withdrew money from the banks they considered as “safe” before, and increased the “haircuts” on repos and difficulties experienced by commercial paper issuers. This caused the short term funding market in the shadow banking system appeared a
Over the years, both lenders and borrowers have endeavoured towards the possibilities of fundamentally disrupting and disintermediating existential financial links, distancing themselves from the financial main, and building new financial operators.
Private banks, regardless of where they operate all over the world, also facing similar demands arise from the
Offshore banking is the action of having a bank account outside of the country of residence. Typically it offers many advantages like greater privacy, low or no taxation, easy access to deposits and protection against local, political, or financial instability, but has also been popular for its use of illegal practices like money laundering and tax evasion. Those against offshore banking view its illegal reputation and predict that it will only cause further damage like providing fund for terrorism or holding underground economies. However other experts believe that offshore banking is a safe haven for depositors and has had a substantial impact on the international economy in today’s world.
As Bain (1992; p.5) states, ‘Financial intermediaries are institutions which attempt to serve the needs of both lenders and borrowers and are often able to reconcile the divergent requirements of borrowers and savers.’ It is important to highlight that there are several different financial intermediaries; banks, building societies, insurance companies and pension scheme companies, but in this case the role of the bank as an intermediary will mostly be considered.