Shadow banking. It’s lending and investing activities that are bank-like but that occur outside the banking system. With interest rates historically low, shadow banking has the potential to cause an entirely different financial crisis.
The Financial Stability Board (FSB) reported that the shadow-banking market had grown to $67 trillion globally by the end of last year. What does this mean for the global financial system?
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The FSB is based in Basel, Switzerland and was created for the purpose of coordinating international regulatory efforts after the 2008 crisis.
Banks and shadow-banking entities loan funds to each other. The significant growth in these activities can create systemic distress because problems created in one side of the market can easily spill over into the other.
Because interest rates are historically low, bank profits are being squeezed to the point that they are moving away from more costly long-term debt in favor of the repo market—overnight loans between banking or bank-like entities that use securities as collateral.
The risk of increasing dependence on the repo market is that any market disruption by an unregulated shadow banking entity could have a ripple effect across the regulated banking system that would create funding problems.
The easy monetary policy of the Federal Reserve is starting to cause financial distortions and investors should monitor banking liabilities and how they are changing.