T. Sabri Öncü

Paul McCulley at the Federal Reserve Bank of Kansas City, Jackson Hole
Economic Symposium in 2007 defined it as: the whole alphabet soup of levered up non-bank investment conduits, vehicles, and structures.
D’Arista and Schlesinger (1993) called it the parallel banking system and defined it as:
Over the last two decades, the US system has been reshaped by the spread of multifunctional financial conglomerates and the emergence of an unregulated parallel banking system. Along with other powerful trends like securitization, these events have broken down the carefully compartmentalized credit and capital marketplace established in New
Deal legislation 60 years ago… Today, a variety of unregulated financial intermediaries operate on the fringes of the financial system .
2

A shadow banking system conducts maturity, credit and liquidity transformation
outside the traditional banking. Thus, not only is shadow banking usually (but not always) less regulated than the traditional banking system, there is also no explicit access to central bank liquidity or public sector credit guarantees.
A shadow banking system decomposes the process of credit intermediation into a
sequence of discrete operations. Therefore, it can be a collection not only of single financial entities acting independently, but also of (and usually is) networks of
multiple financial entities acting together: banks, formal and informal non-bank financial institutions, and even credit rating agencies, regulators and governments.
A shadow banking system is highly leveraged. Further, while its assets are risky and illiquid, its liabilities are prone to “bank runs”.
3

Broad definition:
The “shadow banking system” can broadly be described as “credit intermediation involving entities and activities outside the regular banking system ”.
Narrow definition:
A system of credit intermediation that involves entities and activities outside the regular banking system , and raises and/or
i) systemic risk concerns, in particular by maturity/liquidity transformation, leverage and flawed credit risk transfer,
ii) regulatory arbitrage concerns.
4

Both definitions implicitly assume that banks are credit intermediaries.
But banks are not credit intermediaries .
They are in the business of financing through money creation . Consequently, banks (which are money creators) and NBFIs (which are credit intermediaries) should be regulated differently.
Both definitions implicitly leave the banks out. However, any shadow banking system is essentially a network financial institutions which include banks . Many shadow banking activities are there to circumvent banking regulations , and are therefore a form of regulatory arbitrage , that is, a form of financial engineering through which firms capitalize on loopholes in regulatory systems in order to circumvent unfavourable regulation.
5

Bank Balance Sheet
Assets Liabilities
Loans Deposits
Capital
6

Bank Balance Sheet
Assets Liabilities
Loans
Deposits
Capital
Loans
Special Purpose Vehicle
Assets Liabilities
Equity
(Asset-Backed Securities)
7

Bank Balance Sheet
Assets Liabilities
Guarantees
Loans
Deposits
Capital
Conduit
Assets Liabilities
Loans Debt
(Asset-Backed Commercial Paper)
8

Bank Balance Sheet
Assets Liabilities
Loans Deposits
Capital
Special Purpose Vehicle
Assets Liabilities
Credit Rating Agencies
AAA
BB
NR
Loans Asset-Backed Securities
9

Bank Balance Sheet
Assets Liabilities
Loans
Deposits
Capital
Credit Default Swaps
+
Guarantees
Special Purpose Vehicle
Assets Liabilities
Fannie Mae - Freddy Mac
AIG
Bond Insurers
Loans Asset-Backed Securities
10

Broad data from 2002 to 2014 for 26 jurisdictions and the euro area as a whole.
Advanced Economies: Australia, Canada, Euro Area, France,
Germany, Hong Kong, Ireland, Italy, Japan, Korea, Netherlands,
Singapore, Spain, Switzerland, United Kingdom, United States.
Emerging Market Economies: Argentina, Brazil, Chile, China,
India, Indonesia, Mexico, Russia, Saudi Arabia, South Africa,
Turkey.
For nonbank financial institutions ( NBFI s) broken down to pension funds ( PF s), insurance companies ( IC s) and other financial institutions
( OFI s)
11

Narrow data from 2010 to 2014 based on this classification.
Table 1. The FSB Classification of Shadow Banks by Economic Functions
Economic Function Definition
EF1
Management of collective investment vehicles with features that make them susceptible to runs
Typical Entity Types
Fixed income funds, mixed funds, credit hedge funds, real estate funds
EF2
Loan provision that is dependent on shortterm funding
Finance companies, leasing companies, factoring companies, consumer credit companies
EF3
Intermediation of market activities that is dependent on short-term funding or on secured funding of client assets
Broker-dealers
EF4 Facilitation of credit creation
Credit insurance companies, financial guarantors, monolines
EF5
Securitisation-based credit intermediation and funding of financial entities
Securitisation vehicles
12

Financial Assets of Banks, NBFIs and OFIs
170
140
110
80
50
20
2002 2003 2004 2005 2006
Banks
2007 2008
NBFIs
2009 2010
OFIs
2011 2012 2013 2014
13

Credit by Banks
90
80
70
60
50
40
30
20
2002 2003 2004 2005 2006 2007
Loans+Bonds
2008 2009
Loans
2010 2011 2012 2013 2014
14

Credit by NBFIs
30
25
20
15
10
5
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Loans+Bonds (OFIs) Loans (OFIs) Loans+Bonds (PFs&ICs)
15

Shadow Banks in the AE and EME
35
30
25
20
15
10
5
0
2010 2011 2012
AE EME
2013 2014
16

Regional Distribution of Shadow Banks
16
14
12
10
8
6
4
2
0
2010 2011
North America
2012
Europe & United Kingdom
2013
Other Regions
2014
17

Shadow Banks in the AE
15
12
9
6
3
0
2010
United States
2011
United Kingdom
2012
Germany Ireland
2013
France
2014
Other AE
18

Shadow Banks in the EME
3 000
2 500
2 000
1 500
1 000
500
0
2010 2011 2012
Brazil China India Mexico Other EME
2013 2014
19

Shadow Banks in Top Five Economies as of 2014
9
6
3
0
15
12
2010 2011 2012
United States China Japan
2013
Germany United Kingdom
2014
20