What is Shadow Banking?

2023-01-172023-01-17 Freya

The concept of shadow banking has been around for a long time, and shadow banking in the United States was born in the 1960s and 1970s. At the very beginning of its conception, it has aroused widespread attention and discussion in the academic circles and the media, and shadow banking has also received some international attention because of its potential financial dangers.

Shadow banking is an important financial concept that emerged after the outbreak of the subprime crisis in the United States. It is a way of unlimited credit expansion through bank loan securitization. The core of this approach is to transform the traditional bank credit relationship into a credit relationship hidden in securitization. This kind of credit relationship looks like a traditional bank, but it only performs the functions of a traditional bank without the organization of a traditional bank, that is, it is similar to a shadow banking system. To put it simply, Shadow banking are those financial institutions that can provide credit but are not owned by banks. Because it is difficult to supervise, its impact on currency, including the velocity and scale of circulation cannot be accurately estimated. Therefore, after the global financial crisis in 2008, it has attracted much attention.

It is worth mentioning that investment banks are one of the most important members of shadow banking. When people refer to Wall Street, they refer to investment banks.

In the competition with commercial banks, investment banks are superior in terms of talents, innovative means and technical level. It not only dominates the capital market, but also occupies the mainstream in derivatives and commodity transactions.

What are the types of shadow banking?

The first is shadow banking itself, mainly including investment banks, hedge funds, private equity funds, SIVs and money market funds.

The second type is traditional banks that apply shadow banking methods. These banks still operate under supervision and enjoy the support of the central bank, but they also apply shadow banking methods to some operations.

The third category covers the tools of shadow banking, mainly financial derivatives that allow institutions to transfer risks, increase leverage, and escape supervision.

Shadow banking is a major player in credit markets, capital markets, financial derivatives and commodity trading, and leveraged buyouts. These institutions, which typically lend money and also accept collateral, are financial institutions that hold large amounts of securities, bonds and complex financial instruments through leveraged operations. While bringing prosperity to the financial market, the rapid development and high-leverage operations of shadow banking have brought enormous vulnerability to the entire financial system, and have become the main driving force behind the global financial crisis.

Features of Shadowing Banking

1. The transaction mode adopts the wholesale form, which is different from the retail mode of commercial banks.

2. The leverage is very high. Since they do not have as much capital as commercial banks, shadow banks use a lot of financial leverage to borrow money.

3. Opaque over-the-counter transactions. The product structure design of shadow banking is very complex, and there is little public information that can be disclosed. Most of these financial derivatives transactions are carried out in the over-the-counter market, and the information disclosure system is very imperfect.

4. The main body of shadow banking is financial intermediaries, and the carrier is financial innovation tools. These intermediaries and tools act as credit intermediaries.

5. Since the liabilities of shadow banking are not deposits, they mainly adopt the method of securitization of financial assets. The original purpose is to diversify risks. Therefore, shadow banking are not subject to strict supervision on depository monetary institutions, and there is a behavior of regulatory arbitrage.

Features of Shadowing Banking

1. The transaction mode adopts the wholesale form, which is different from the retail mode of commercial banks.

2. The leverage is very high. Since they do not have as much capital as commercial banks, shadow banks use a lot of financial leverage to borrow money.

4. The main body of shadow banking is financial intermediaries, and the carrier is financial innovation tools. These intermediaries and tools act as credit intermediaries.

Risks and Dangers of Shadow Banking

1. Shadow banking can bring more diverse financial services and promote the diversified development of the financial market, but there are also certain risks. For example, some shadow banks have hatched many products with the help of so-called innovative shells, causing some market chaos, so it is expected to require rectification. After all, some shadow banks are not standardized, opaque and may have high risks, and some products have unclear laws, insufficient information disclosure, false publicity, etc.

2. Encouraging the transition from the real to the virtual, various shadow banking business models that are completely idling and for the purpose of arbitrage continue to emerge. Some banks issued a large number of interbank certificates of deposit, and even conducted interbank wealth management investment and outsourcing investment through spontaneous purchases and interbank deposit certificate swaps, etc., inflating assets and liabilities. Funds only circled within the financial system and did not really flow to the real economy. Even if part of the funds eventually flow to the real economy, the cost of funds will increase significantly due to the lengthening of the chain. Some trust companies nested trust plans issued by other companies to form a large number of TOT, and the funds did not leave the financial system.

3. Endanger social stability. Due to lax, insufficient and blank supervision, illegal and unlicensed driving financial activities are rampant. The financial industry has a high degree of externality, and some financial risks have spilled over into social risks. For example, in the fields of bank wealth management, trust, securities asset management, private equity funds and other fields, because products cannot be paid on time, investors’ petitions and gatherings continue to occur.

4. The business of shadow banking often runs across multiple markets and financial institutions, which greatly increases the contagion of financial risks among different markets and institutions. Once the high-risk shadow banking business gets out of control, it may cause systemic risks.

Of course, in order to prevent the rebound of shadow banking risks, it is necessary to maintain regulatory focus on banking and financial institutions, urge banks and other financial institutions to implement regulatory requirements, effectively standardize and rectify shadow banking and cross-financial business, unswervingly promote the transformation of wealth management business, and strengthen banking and other financial institutions. The compliance construction of institutions can better serve the real economy. Banking financial institutions need to play a role in serving the real economy, and they must not lose their financial origins for small profits.