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Shadow Banking

April 11, 2017
Man in suit by Matthew Henry, Toronto, Ontario, via Unsplash

Yesterday, I mentioned how some art auction houses have become highly attractive to money launderers for anonymous sales and lax lending policies. This is part of a global trend called “shadow banking” which poses significant systemic risks to markets in the U.S. and abroad.

What is it?

Shadow banking is a catch-all phrase for financial services that occur outside of the regular banking and investment system (and typically outside of regulatory control.) It can take many forms including risky financial products, loan-shark operations, off-the-books lending, or auction-house financing by art dealers.

Why does it matter?

Shadow banking creates systemic risk to the financial stability of major institutions and economies. Much of the money used in shadow banking is issued by regulated entities that fail to appreciate or report the risk posed by shadow banking activities.

How big is the problem?

In 2014, there were about $80 trillion in shadow banking assets globally. About half of this was deemed risky to the financial system.

Although the nature and size of shadow banking activities varies by country, the risky assets in the U.K. and Ireland were bigger than their economies.

Bloomberg notes that many of the serious runs during the 2008 financial crisis were actually on shadow banks, not regular bank deposits. However it is unclear whether shadow banking can be effectively stopped or if it is a financial black market that will always exist.


Photo: Matthew Henry.

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