The rise of the dark shadow
Shadow Banking, sounds bad doesn’t it? The following report from the Financial Stability Board gives various definitions of what it is and more importantly quantifies it. Exhibit 3-1 on page 11 really shows how different financial markets across the world really are:
• Financial Stability Board (2014) Global Shadow Banking Monitoring Report 2014. Available at: http://www.financialstabilityboard.org/2014/11/global-shadow-banking-monitoring-report-2014/
This all has enormous implications. It is great that the banks, backed by central bank guarantees, or at least implied guarantees, are not taking such a large part of the financial markets – the tax payer should be relieved. The negative is that the banks are backed by deposit guarantee schemes and when have access to central bank lender of last resort facilities. They also provide customers with pretty much guaranteed liquidity and act to create diversified portfolios which individual savers could never achieved and effectively mutualise the risks associated with saving.
The shadow system offer none of this, and yet if it were to start failing would central banks simply let the all the paw brokers, peer to peers, hedge funds, private equity and other investment groups go to the wall. They could, and indeed should, but the implications for the wider economy would be very great, and, of course, the banks would undoubtedly get drawn in either because they are providing much the funding for the shadow system or simply because they are creating similar assets and when the music stops they will see their assets also decrease in value.
It’s certainly a matter of some debate which is growing in the popular press. Time recently speculated on where the next financial crisis will come from (though we are probably a little over sensitised to the issue now). The Guardian has gone further using the FSB report and Mark Carney’s comments to speculate on whether in the next crisis, the rise of market-based disintermediated (in a way) finance will mean the Bank would have to directly bail out markets. Baling out banks is unpopular enough, bailing out “markets”, well of course the spin would be bailing out all our pensions, the counter view will be that tax payers would be bailing out the spivs:
• Foroohar, R (2014) http://time.com/3554603/next-financial-crisis/. Time. Available at:
• Inman, P (2014) Financial crisis repeat could force Bank of England to bail out markets. The Guardian. Available at: http://www.theguardian.com/business/2014/nov/07/bank-of-england-financial-crisis-repeat-bailout-markets-mark-carney