An October 2014 report from the International Monetary Fund reviewed the current state of the global shadow banking system. The report highlights the growing size and influence of the shadowing banking market worldwide, especially in emerging nations and the U.S.

US SB System

Overview of shadow banking

Shadow banking is generally defined as credit intermediation outside the conventional banking system, and represents at least one-fourth of total global financial intermediation today. The international Financial Stability Board has been monitoring and measuring shadow banking since 2011, and is working to improve the regulatory framework to more effectively address the risks created by shadow banking.

Shadow Banking

The U.S., the eurozone, and the UK have the largest shadow banking systems based on FSB data. Shadow banking assets as a share of GDP are twice those of any other area in the UK, and the United States is the only country where shadow banking assets are greater those of the conventional banking system. Of note, shadow banking has seen consistent growth in emerging market nations since 2004.

SB Lending

Shadow banking can pose systemic risks

The recent global financial crisis made it clear that shadow banking can put the stability of the financial system at risk without sufficient oversight (ie, regulation).  A number of shadow intermediaries (including money market mutual funds and securitization vehicles) in the U.S. and Europe were over-leveraged and/or were holding large amounts of illiquid assets during the crisis. This made them vulnerable to “runs” when investors lined up to withdraw large amounts of funds at short notice.

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These runs led to sudden, unplanned asset sales, reducing asset values and spreading the financial stress to traditional banking system. Fortunately, global regulatory reforms coordinated by the FSB have begun to require greater disclosure of asset values, more thoughtful governance, ownership reforms, as well as more supervision and regulation of shadow banks.

U.S. shadow banking system expanding into new territory

Shadow Banking

While all forms of shadow banking are growing fast in emerging economies, most of the growth in the U.S. and UK shadow banking sectors is coming from new loan products and investment strategies. The IMF report notes: “In advanced economies, shadow banking seems to be shifting to less-well-monitored activities. Only investment funds, especially bond funds, country-specific entities, and “other” entities continued to grow after 2008 (Figure 2.5). The growth of the “other” entities could imply a shift in financial stability risk toward activities that are not as well understood. Box 2.2 suggests that these may comprise new forms of direct lending and over-the-counter derivatives trading.”

Alternative measures

H/T Streeteye