Shadow Banking

Shadow banking refers to financial intermediation by non-bank financial institutions that perform bank-like functions (maturity transformation, liquidity transformation, credit intermediation) outside traditional banking regulation. Examples include money market funds, hedge funds, private equity, securitization vehicles, repo markets, and finance companies. The shadow banking system grew to nearly equal traditional banking before 2008, reaching $60 trillion globally. For instance, money market funds act like banks by taking short-term deposits and making loans (buying commercial paper) but lack deposit insurance and central bank access. During the 2008 crisis, shadow banking amplified systemic risk: the Reserve Primary Fund ‘broke the buck,’ repo markets froze, and structured investment vehicles collapsed. Post-crisis reforms target shadow banking through money market fund regulations, skin-in-the-game requirements for securitization, and enhanced monitoring by the Financial Stability Board. However, shadow banking continues growing, particularly in China where it includes wealth management products and peer-to-peer lending. Benefits include credit availability and innovation, but risks remain from regulatory arbitrage and interconnectedness with traditional banks.