Shadow banks are other financial institutions active in the money business outside the regulated banking system.
What is the explanation for the shadow label, this is because these institutions use deposits that are insured by schemes like retail or wholesale banks do. Also, they cannot borrow money from the central bank, therefore they are only lightly regulated and financial supervisors don’t have a clear picture of shadow bank activities. Shadow banks play a range of roles that complement bank services and also are interconnected with regulated banks.
An example is the activity of companies that are active in niche businesses such as car financing. Shadow banks can appear in many forms, for example, as money market funds, mutual funds, hedge funds, and credit insurance or mono lines. Investment banks have shadow bank characteristics and are active in setting up shadow bank entities like securitization vehicles.
Examples are special purpose and special investment vehicles are conduits. However, also regulated banks can set up shadow bank activities using complex legal structures. As a result of the free market de-regulation culture of the last decades, the size of the shadow banking system has grown dramatically.
For example, in America, shadow banking activities exceed the regulated bank sector. In Western countries, approximately 50 percent of all banking assets are in the shadow banking system. To help you understand the de-regulation effect of the financial system, imagine this system as a highway with no speed limits, rules, or police, some drivers will be tempted to drive dangerously and cause serious accidents.
Deregulation can only work if all participants act disciplined, responsible, and supportive. The growth and volume of the shadow banking industry have contributed to the instability of the financial system by taking high risks in search of high returns. The pipe dream of a self-disciplined financial system popped up in 2008, resulting in a pile of financial crashes that have damaged our economies severely.
This diagram shows the rapid growth of shadow banking assets in the financial world as a result of these regulations, banks and other financial institutions benefit our economy, but they need a minimum level of regulation to prevent irresponsible risk-taking and system-disrupting accidents with sufficient regulations. Accidents will still happen, but the risk of an imploding financial system will be contained by the effective supervision of banks and other financial institutions.
The main task of the Financial Stability Board, or FSB, is to assist an effective, regulated, and supervised financial sector. The FSB is located in Basel, Switzerland. It’s a secretariat hosted by the Bank for International Settlements, also known as the Big Bank. Since the 70s, the Bank of International Settlements has played an important role in regulation.
