Shadow banking system

Shadow banking system

The “shadow banking system” or the “shadow financial system” is largely formed by non-bank financial institutions that like banks, borrow short and in liquid forms and lend or invest long in more illiquid assets [http://www.financialweek.com/apps/pbcs.dll/article?AID=/20080228/REG/346385380/1036 NYU professor predicting a whale of a bear market, February 28, 2008] . They are able to do this via the use of credit derivative instruments which allow them to evade normal banking regulations, e.g. those related to specifying ratios of capital reserves to debt.

The term "Shadow banking system" is attributed to Paul McCulley of PIMCO by the latter's Bill Gross [http://money.cnn.com/2007/11/27/news/newsmakers/gross_banking.fortune/ Beware our shadow banking system, Bill Gross, November 28 2007] .

Several new institutions and vehicles have emerged in American and European markets this decade that have come to play an important role in providing credit across the financial system. [http://www.ft.com/cms/s/0/42827c50-abfd-11dc-82f0-0000779fd2ac.html?nclick_check=1 Out of the shadows: How banking’s secret system broke downBy Gillian Tett and Paul J Davies,December 16 2007 18:33 ] Until summer 2007, structured investment vehicles (SIVs) and collateralised debt obligations (CDOs) attracted little outside attention. Often affiliated to major banks, they are not always fully recognised on balance sheets.

The system includes SIVs, conduits, money market funds, monolines, investment banks, hedge funds and other non-bank financial institutions. These institutions are subject to market risk, credit risk and especially liquidity risk, since their liabilities are short-term while their assets are more long term and illiquid.

As they are not depositary institutions, these entities do not have direct or indirect access to the central bank's lender-of-last-resort support. In conditions of market illiquidity, they could go bankrupt if unable to refinance their short-term liabilities.

The shadow banking system has been blamed [http://www.ft.com/cms/s/0/42827c50-abfd-11dc-82f0-0000779fd2ac.html?nclick_check=1 Out of the shadows: How banking’s secret system broke downBy Gillian Tett and Paul J Davies,December 16 2007 18:33 ] for aggravating the subprime mortgage crisis and helping to transform it into a global credit crunch. [ [http://www.newleftreview.org/?getpdf=NLR28403&pdflang=en Blackburn - Subprime Crisis] ]

Examples

*Lehman Brothers Holdings (Filed for bankruptcy on September 15, 2008)
*Charles Schwab
*E-trade

ee also

*Recession
*Structured investment vehicle
*Subprime crisis background information

References

* cite news
url=http://www.ft.com/cms/s/0/622acc9e-87f1-11dd-b114-0000779fd18c.html
title=The shadow banking system is unravelling
first=Nouriel
last=Roubini
date=2008-09-21
accessdate=2008-09-21


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