## Shadow Banks: Out of the Eyes of Regulators

## Source details

**Canonical URL:** [Shadow Banks: Out of the Eyes of Regulators](https://www.imf.org/en/publications/fandd/issues/series/back-to-basics/shadow-banks)

## Other formats

- [Markdown version](/en/publications/fandd/issues/series/back-to-basics/shadow-banks/index.md)
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## Bibliographic details
- Authors: Laura Kodres
- Published: May 16, 2019

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### Definition and mechanics of shadow banking
- Shadow banks: financial institutions that "look like a bank and act like a bank" but are not subject to traditional bank regulation.
- Term coined by Paul McCulley in a 2007 speech; originally emphasized US nonbank institutions performing maturity transformation.
- Core intermediation functions (per the Financial Stability Board):
  - maturity transformation: obtaining short-term funds to invest in longer-term assets;
  - liquidity transformation: using cash-like liabilities to buy harder-to-sell assets such as loans;
  - leverage: employing techniques such as borrowing money to buy fixed assets to magnify potential gains or losses;
  - credit risk transfer: transferring borrower default risk from originators or issuers to other parties.
- Examples of shadow-banking entities and activities:
  - broker-dealers funding assets using repurchase agreements (repos);
  - money market mutual funds pooling investors’ funds to purchase commercial paper or mortgage-backed securities;
  - finance companies that sell commercial paper and use proceeds to extend credit to households;
  - the securitization chain that turns home mortgages into mortgage-backed securities largely outside direct regulatory view.

### Systemic vulnerabilities and crisis dynamics
- Problems arise when investors simultaneously withdraw short-term funding, forcing shadow banks to sell assets ("fire sales"), which depress asset prices and propagate losses across entities.
- Contributing features of shadow banking during the global financial crisis:
  - lack of disclosure and information about asset values or even asset composition;
  - opaque governance and ownership links between banks and shadow banks;
  - little regulatory or supervisory oversight comparable to traditional banks;
  - virtually no loss-absorbing capital or cash for redemptions;
  - lack of access to formal liquidity support (for example, central bank funds) to prevent fire sales.
- Interconnections with regulated banks amplified systemic stress:
  - some shadow banks were controlled by commercial banks and were salvaged for reputational reasons;
  - arm’s-length connections impaired markets (for example, commercial paper markets) that also funded banks;
  - opacity made it unclear counterparty exposures and contingent claims.

### Size, monitoring, and evolving geography
- Estimating the size of shadow banking is difficult because many entities do not report to regulators.
- FSB global monitoring (mandated by the G20) expanded since 2011; covers 28 jurisdictions and the euro area.
- Entity-based findings (end-2015 data):
  - euro area shadow banking system: 33 percent of the total (up from 32 percent in 2011);
  - US shadow banking system: declined from 33 percent to 28 percent.
- Global totals reported across contributing jurisdictions:
  - peaked at $62 trillion in 2007;
  - declined to $59 trillion during the crisis;
  - rebounded to $92 trillion by the end of 2015.
- Functional (activity-based) categorization (27 jurisdictions): total $34.2 trillion, with asset-management-type activities making up some 22 percent of that total.
- Limitations of current measures:
  - FSB monitoring does not measure the amount of debt used to purchase assets (leverage);
  - does not fully capture the system’s amplification potential or the channels transmitting problems across sectors (though some linkage attempts use balance sheet data between nonbanks and banks).

### Policy responses and supervisory actions
- Authorities have increased data collection and enhanced monitoring to search for hidden vulnerabilities.
- Banking supervisors are examining banks’ exposures to shadow banks and strengthening capital and liquidity regulations to contain contagion.
- Some authorities have expanded reporting scopes and altered the regulatory perimeter to capture shadow-banking entities and markets.
- Authorities are discouraging regulatory arbitrage—shadow banks tailoring behavior to fall under the weakest or no regulators, domestically or globally.
- Ongoing challenges for authorities:
  - piecing together disparate and incomplete data to assess systemic risks associated with activities, entities, and instruments in the shadow banking system;
  - improving measurement of leverage and cross-sector linkages to better gauge systemic importance.

*Content by Laura Kodres (Back to Basics). F&D Magazine page overview.*

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_Source: https://www.imf.org/en/publications/fandd/issues/series/back-to-basics/shadow-banks_