The Problem With Shadow Banking – “The U.S. shadow banking sector is alive and well, growing at a fast pace and remains opaque,” MarketWatch’s Greg Robb writes, citing top economists at the University of Chicago, Harvard and the Fed.
Why it matters: The sector might not cause the next downturn, but Dallas Fed president Robert Kaplan says he’s worried it could be “an accelerant” to a recession that does come.
What’s happening: “The shadow banking sector, now called by the more polite term ‘private debt market’ has roughly tripled in size over the past few years and one estimate puts the size around $1.2 trillion,” Robb writes from the American Economics Association conference in San Diego.
One big risk of the shadow banking sector is that investors can demand their money at any time. That could lead to a run on their assets, according to Jeremy Stein, a former Federal Reserve governor and a finance expert at Harvard.
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The U.S. Treasury Department wants international financial regulators to stop using the term “shadow banking” when referring to non-bank lenders, according to a report released Thursday. Instead, it wants such activities to be referred to as “market based finance.” Per the report:
“Applying the term ‘shadow banking’ to registered investment companies is particularly inappropriate as the word ‘shadow’ could be interpreted as implying insufficient regulatory oversight, or disclosure.
Registered investment companies, as described in this report, are regulated by the SEC and provide extensive public and regulatory transparency of fund portfolio holdings on a quarterly, monthly and, in some cases, daily basis.”
Etymology: The term “shadow banking” was coined by former bond fund manager Paul McCulley in 2007, and soon became ubiquitous as such lending helped spark the following year’s financial crisis. Today the term is used fairly broadly, particularly as the securitization mania of 2007 has given way to new lending booms like private credit funds.
Bottom line: While “shadow banking” may be a pejorative term — which seems to be Treasury’s gripe — it hasn’t stopped the industry’s rapid growth. Nor has that growth sparked increased oversight, as non-bank lenders continue to operate under much less oversight than can their banking peers.
