The lure of shadow banking
Shadow banks helped cause the financial crisis. Better regulated, they could help avert the next one
MARK CARNEY, governor of the Bank of England and head of the Financial Stability Board (FSB), an international watchdog set up to guard against future financial crises, was recently asked to identify the greatest danger to the world economy. He chose shadow banking in the emerging markets. Shadow banking certainly has the credentials to be a global bogeyman. It is huge, fast-growing in certain forms and little understood—a powerful tool for good but, if carelessly managed, potentially explosive.
The FSB, which defines shadow banking as lending by institutions other than banks, reckons it accounts for a quarter of the global financial system, with assets of $71 trillion at the beginning of last year, up from $26 trillion a decade earlier. In some countries, shadow banks are expanding even faster: in China, for instance, they grew by 42% in 2012 alone.
But there is disagreement about what counts as shadow banking. The core is credit (everything from China’s loan-making trust companies to Western peer-to-peer lending schemes and money-market funds). A broader definition, however, would include any bank-like activity undertaken by a firm not regulated as a bank: think of the mobile-payment systems offered by Vodafone, the bond-trading platforms set up by technology firms or the investment products sold by BlackRock.
As our special reportexplains, services like these are proliferating because orthodox banks are on the back foot, battered by losses incurred during the financial crisis and beset by heavier regulation, higher capital requirements, endless legal troubles and swingeing fines. The banks are retrenching, cutting lending and shutting whole divisions. In America, for instance, investment banks are no longer allowed to trade on their own account, only on behalf of clients. British banks, meanwhile, have slashed their loans to businesses by almost 30% since 2007, with Barclays this week confirming plans to shed up to 14,000 staff. Shadow banks are filling these gaps.
Frailty, thy name is bank
Nobody is too worried by competition to banks in their ancillary businesses: if, say, Google can help people manage their money more efficiently, that is to be welcomed. The argument is about credit. In some ways, it is a good thing that lending outside the banking system is expanding. Banks are regulated for a reason: they have big “maturity mismatches” (borrowing money largely for short periods while lending it out for the longer term), enormous leverage and are tangled up in complicated ways with other financial institutions, so they are especially fragile. And when they get into trouble, taxpayers tend to end up on the hook, because governments both guarantee deposits and are frightened to let such big and complicated institutions fail. So if some lending is moving from banks to less dangerous entities, the financial system should be safer.