Shadow Banking - stop hiding in the shadows.

The shadow banking system is a term for the collection of non-bank financial intermediaries that provide services similar to traditional commercial banks.

This is a system of non-financial institutions that borrow money in the short term and take that money to invest in longer term assets.  Shadow banking systems are able to avoid standard banking regulations through the use of credit derivatives.  Credit derivatives are said to be one of the significant problems which contributed to the subprime mortgage crisis in 2007-2008.

Examples of important components of the shadow banking system include securitization vehicles, asset-backed commercial paper [ABCP] conduits, money market funds, markets for repurchase agreements, investment banks, and mortgage companies.

 

Like regular banks, shadow banks provide credit and generally increase the liquidity of the financial sector. Yet unlike their more regulated competitors, they lack access to central bank funding or safety nets such as deposit insurance and debt guarantees.  In contrast to traditional banks, shadow banks do not take deposits. Instead, they rely on short-term funding provided either by asset-backed commercial paper or by the repo market, in which borrowers in substance offer collateral as security against a cash loan, through the mechanism of selling the security to a lender and agreeing to repurchase it at an agreed time in the future for an agreed price.

Shadow banks can be involved in the provision of long-term loans like mortgages, facilitating credit across the financial system by matching investors and borrowers individually or by becoming part of a chain involving numerous entities, some of which may be mainstream banks.

Leverage is considered to be a key risk feature of shadow banks, as well as traditional banks. Leverage is the means by which shadow banks and traditional banks multiply and spread risk.

Shadow institutions are not subject to the same prudential regulations as depository banks, so that they do not have to keep as high financial reserves relative to their market exposure. Thus they can have a very high level of financial leverage, with a high ratio of debt relative to the liquid assets available to pay immediate claims. High leverage magnifies profits during boom periods and losses during downturns.


Is cryptocurrency relevant to shadow banking?


Cryptocurrency continues to evolve.  Started with zero regulation, but they may be creeping into the system.  It all depends on whey you are reading this page and if we made any updates to the page recently (today is 2018; what year are you living in now).  Our guess is more regulations will be added to the cryptocurrency banking system.

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