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| Anastasia Nesvetailova |
The epoch of Market based funding: Shadow Banking
In the midst of a 2008 financial crisis, a senior French banker revealed that “It takes me about two hours to assemble a team of finance geeks and lawyers to devise a product or a transaction that would bypass any new rule or regulation coming our way”. And it is this confession that captured the essence of the challenge that daunts the regulators and policy-makers in the aftermath of the most devastating financial crisis since the 1930s. It seems that whatever financial regulators come up with, industry players are likely to find a way to bypass it. Or at the very least, minimize its impact. The most compelling illustration of this blunt logic of financial evolution is the phenomenon of shadow banking, a term that entered public debate in 2007 and has since preoccupied regulators and finance experts.
What’s in the name?
Simply-put, shadow banking depicts a market-based funding system (rather than bank-based), or “money market funding of capital market lending” (Mehrling et al 2012). More extensively, it implies a complex network of credit intermediation outside the boundaries of the traditional, regulated bank. It was the crisis of 2007-09 that brought the scale of shadow banking to light and transformed a phenomenon considered to be a benign force of financial innovation and competition, into a political problem. Paul McCulley (2009) argued that the growth of the shadow banking system, which operated legally yet entirely outside the regulatory realm “drove one of the biggest lending booms in history, and collapsed into one of the most crushing financial crises we’ve ever seen.”
In the midst of a 2008 financial crisis, a senior French banker revealed that “It takes me about two hours to assemble a team of finance geeks and lawyers to devise a product or a transaction that would bypass any new rule or regulation coming our way”. And it is this confession that captured the essence of the challenge that daunts the regulators and policy-makers in the aftermath of the most devastating financial crisis since the 1930s. It seems that whatever financial regulators come up with, industry players are likely to find a way to bypass it. Or at the very least, minimize its impact. The most compelling illustration of this blunt logic of financial evolution is the phenomenon of shadow banking, a term that entered public debate in 2007 and has since preoccupied regulators and finance experts.
What’s in the name?
Simply-put, shadow banking depicts a market-based funding system (rather than bank-based), or “money market funding of capital market lending” (Mehrling et al 2012). More extensively, it implies a complex network of credit intermediation outside the boundaries of the traditional, regulated bank. It was the crisis of 2007-09 that brought the scale of shadow banking to light and transformed a phenomenon considered to be a benign force of financial innovation and competition, into a political problem. Paul McCulley (2009) argued that the growth of the shadow banking system, which operated legally yet entirely outside the regulatory realm “drove one of the biggest lending booms in history, and collapsed into one of the most crushing financial crises we’ve ever seen.”
