BANK OF ISRAEL
Office of the Spokesperson and Economic Information
January 13, 2016
Press release
Characteristics and risks of shadow banking worldwide and in Israel
Shadow banking—nonbank credit intermediation activity—is steadily developing around
the world. Notable examples of shadow banking are guaranteed-yield money market
funds, securitization, hedge funds, broker-dealers who supply credit to their customers
along with executing their transactions, and non-institutional credit intermediation
companies. The growth of shadow banking worldwide in 2011–14 was greater than
growth of banks. In 2014 alone, shadow banking assets increased by $2 trillion, to $80
trillion.
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Shadow banking, and particularly non-institutional credit intermediation, incorporates
numerous advantages, chief among them increasing the supply and broadening the
range of sources of credit in the economy. However, alongside these advantages, such
activity incorporates risks, which are liable to impact on financial stability, and
financing from the public via tradable bonds heightens these risks.
Supervision of credit intermediaries needs to be not only consumer oriented but also
stability oriented. Prudential supervision has to reduce the risk of a specific noninstitutional credit intermediary finding itself in distress, as well as reduce the impact
of that distress on the overall economy (macroprudential risks). Regulation should be
in line with the level of risk created by such entities to the financial system and to the
economy in general.
It is very important that prudential regulation of entities that provide credit
(particularly in large sums) is aligned with their level of risk—the risk in entities that
take deposits from the public is greater, while supervision of entities that finance the
credit through bonds alone would likely be more lenient.
Non-institutional credit intermediation in Israel is part of the shadow banking system,
which is consistently developing worldwide. These are companies whose main activity is
providing credit, and that are not banks, insurance companies, pension funds or provident
funds. In view of evolving regulatory changes, which relate to regulation of the industry,
and in view of the development of this industry in Israel, this box will review the
characteristics of shadow banking, and of non-institutional credit intermediation in
particular.
Shadow banking is nonbank credit intermediation. Similar to banks, shadow banking
deals with providing credit and liquidity, but shadow banking, as opposed to banking,
generally does not include taking deposits and is not under the same tight supervision as
deposit-taking banks. Notable examples of shadow banking are guaranteed-yield money
market funds1, securitization2, hedge funds, broker-dealers who supply credit to their
customers as part of executing transactions for them, and non-institutional credit
intermediation companies.
The growth of shadow banking worldwide in 2011–14 was greater than that of banks. In
2014 alone, shadow banking assets increased by $2 trillion, to $80 trillion. Shadow
banking is not developed in Israel. Its riskier sectors do not exist here in large scope, and
therefore, currently, the risk to financial stability inherent in them is not great. However,
in Israel there is a developing market of non-institutional credit intermediation—an
examination of public non-institutional credit intermediation companies indicates that
they focus on providing low-duration loans to small and medium sized businesses that
find it difficult to receive bank funding.
Shadow banking, and particularly non-institutional credit intermediation, incorporates
many advantages, chief among them increasing the supply and broadening the range of
sources of credit in the economy, and making it more accessible to a wide range of
borrowers. Shadow banking even contributes to increased competition within the
financial system. However, alongside those advantages, there are risks inherent in such
activity that are liable to impact on financial stability and on the economy, and to increase
its vulnerability to crises. In a case of several shadow banking financial institutions, or a
single entity, getting into distress, there is concern that the negative impact would grow
stronger and spread to other sectors through the mutual relationships between shadow
1
The risk inherent in guaranteed yield money market funds is significant, as these entities hold liquid
assets, and are thus exposed to economic distress and bankruptcies. In a case of mass withdrawals from the
funds, the value of the assets declines, but the financial commitment requires the entities to pay the full
deposit. As there is a gap between the value of the assets and the value of the liabilities, these entities are
considerably exposed to “runs” and prudential risk. The risk was actualized due to the global financial
crisis: many guaranteed-yield money market funds around the world went bankrupt.
2
In a securitization transaction, securities are issued whose maturity value is ensured by pre-defined cash
flows, which are expected to derive from a defined asset or group of assets. For a deeper discussion, see the
report by the Committee to Promote Securitization in Israel, November 2015.
banking and the rest of the financial system. Furthermore, the failure of a shadow
banking entity or entities is liable to call into question the public’s trust in other financial
intermediaries, a situation that may be reflected in herd behavior such as
selling/withdrawing assets that were invested/deposited at other financial institutions (for
example, mass withdrawals from provident funds and mutual funds, even those that are
not significantly invested in the failed entity). Thus, financial distress among financial
intermediaries may be created, which leads to a shortage of credit, which negatively
impacts on real economic activity. Examples of the effect of financial crises in the noninstitutional credit intermediation industry on activity in the overall economy can be
found in the crises that developed in South Korea and New Zealand.
Raising financing from the public through tradable bonds increases the risks inherent in
shadow banking activity. First, the information asymmetry between borrower and lender
reduces the public’s ability to supervise the investment and increases the ability of the
financial entity to take excess risks. Thus, the risk of overreaction and contagion also
increases. Second, as this is financing through money that the financial institution is to
return to the investing public3, it is contingent on the state of the markets and the ability
to roll over the debt through the markets. Therefore, an external shock that leads to a
standstill in the markets or to a loss of confidence in financial institutions would make it
difficult for such institutions to raise new funds in order to roll over the debt, and thus,
together with the standstill in granting credit, would make it difficult for the institutions
to meet their obligations. The shorter the duration of the liabilities, and the larger the gap
between that and the duration of assets, the more intense the problem is. The tradability
of the bonds could lead to a fire sale, negatively impacting on the bonds’ value, which
will make future financing, meeting obligations, and providing credit even more difficult.
Third, financing by issuing tradable bonds increases the scope of the entity’s potential
activity and leverage, as well as all the risks inherent in it. Thus, in Europe, as a direct
result of these risks, regulation that is similar to banks—even if more lenient—is imposed
on an intermediary issuing bonds in order to provide credit.
These risks are not exclusive to the shadow banking system; they are characteristic of the
overall credit intermediation system, at the center of which are banks and financial
institutions, but the supervision of banks and financial institutions acts to minimize and
monitor these prudential risks. In the absence of extensive supervision mechanisms,
shadow banking, and particularly the activities of non-institutional credit intermediaries,
is fragile and less stable than traditional banking activities.
This box emphasizes the importance of balanced prudential supervision of shadow
banking institutions in addition to consumer-related supervision, particularly of entities
3
With regard to sources of financing from the public that have to be repaid, we make a distinction between
financing through current-account deposits and financing through bonds and term deposits. The prudential
risk inherent in the former method is greater.
financing themselves by issuing bonds to the public. Appropriate prudential supervision
is capable of reducing the risks inherent in shadow banking, and of allowing this market
to continue to exist and develop. In this way, the public will be able to benefit, with
confidence, from the advantages inherent in this activity.
Shadow banking worldwide a , according to
the broad definition, by institutionb, 2014
Money
market
funds
Trust
companies
Other
Noninstitutional
credit
intermediaries
5%
Securitization
7%
Hedge
funds
Real estate
funds
Brokerdealers
Investment
funds
a
The countries are: Argentina, Australia, Brazil, Canada,
Sw itzerland, Chile, China, Germany, Spain, France, UK, Hong
Kong, India, Indonesia, Ireland, Italy, Japan, South Korea, Mexico,
Netherlands, Russia, Saudi Arabia, Singapore, Turkey, US, South
Africa.
b
Distribution of shadow banking by institutions w as based on a
sample of 26 jurisdictions; based on that, shadow banking assets
total $68.1 trillion. In contrast, the assessment of shadow banking
assets presented in this box w as based on a w ider sample of 20
jurisdictions and the eurozone. Based on that, shadow banking
assets total $80 trillion.
SOURCE: FSB’s “Global Shadow Banking Monitoring Report 2015”.