- Shadow banking comprises a huge proportion of the market for credit
- Shadow banking activities were an important cause of the financial crisis (2007-2009)
- The nature of shadow banking varies from traditional lending in that it is more pro-cyclical and entails more systemic risk
- Many market participants and policy makers do not have an adequate understanding of these activities and their effects on markets
"The Fed now estimates that in early 2008 shadow banking was $20,000bn in size, dwarfing the $11,000bn traditional banking system."
Gillian Tett, “Road map that brings shadow banking out into the open”, The Financial Times, November 19, 2010
"ZeroHedge has been covering the topic of Shadow Banking for over two years, as it is our contention that this massive, and virtually undiscussed component of the US real economy (that which … did not exist until the late 1990s and yet is the same size as total US GDP!), is, on the margin, the most important one: in fact one that defines, or at least should, monetary policy more than most imagine, and also explains why despite trillions in new money having been created out of thin air, the flow through into the general economy has been negligible."
“On the Verge Of A Historic Inversion In Shadow Banking, zerohedge.com, 6/25/2012
"For if Citi data are correct, the real source of the current credit crunch is not a collapse in bank loans, but the implosion of the shadow banking world."
"The more fundamental point is that these collateral chains were shown to be systematically toxic in the Lehman collapse. They can become an awesome engine of contagion."
"Over the past decade, the shadow banking system provided sources of funding for credit by converting opaque, risky, long-term asset into money-like, short-term liabilities."
"Widespread collateral use exacerbates the problem of herding behavior. In periods of stress, market participants all seek more collateral or need to sell pledged securities, increasing market instability."
"But by far the biggest threat with shadow banking ... is that it works brilliantly in an environment of increasing leverage, but should deleveraging commence, is an asset price black hole ... [as] there are no real assets at the end of a rehypothecation chain."
"The main risk is a repo transaction is market risk"
- It is critical to incorporate the dynamics of shadow banking to understand what is really happening in credit markets
- The system works well when leverage is increasing, but collapses violently when leverage decreases
- The marginal dollar of credit is coming from the shadow banking system which highlights its importance
- The proliferation of shadow banking has created a different and fundamentally riskier credit market than we've had in the past