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The Shades of Shadow Banking

The Shades of Shadow Banking

Shadow banking has been growing in size in both advanced economies as well as developing economies. One estimate by the Financial Stability Board (2013) states that in the year 2012, the size of global shadow banking was of the order of USD 71 trillion and accounted for about 25 percent of total financial assets and about 50 percent of total banking system assets. In GDP terms, global shadow banking accounted for about 117 percent of the GDP of the jurisdictions surveyed in 2012. Some researchers have argued that in the light of recent global financial crisis there is stricter need for monitoring and regulating the activities of shadow banking.

In the context of growing economies, it is argued that shadow banking plays a useful role in smoothening credit delivery through financial inclusion as they can facilitate access to credit for the excluded. They are believed to play a complementary role for the organized banking systems. However, concerns are raised in the light of the stricter implementation of new capital and liquidity requirements under Basel III proposals that some of the private sector banking corporations would push some of their activities out of their banking domain into the shadow banking activities in order to escape from the capital requirements. In addition, there has been a latent public perception that shadow-banking activities aid and abet the Ponzi schemes, which always lead to scams causing a heavy toll on the financial health and savings behaviour in the economy. Though there may be certain stark differences in the way the shadow banking institutions operate as compared to banks, in the very nature of shadow banking, sometimes, there is only a thin line separating the two.

One of the severe challenges for the regulators is of determining the scale and size of shadow banking operations as this landscape is continually evolving in different dimensions by exploiting the arbitrage gaps in the regulatory framework which otherwise seeks to control them. Furthermore, unlike the banking sector, which have a very good statistical coverage, consistent database on shadow banking is not available given the heterogeneous nature of shadow banking entities, instruments and activities. Since there is considerable opaqueness in the structure, size, operations and inter-linkages of shadow banking with commercial banks and other structures of the financial system, it might misrepresent the information content of monetary policy pointers and thereby weaken the conduct of monetary policy. There is also a view that shadow banking activities cause procyclicality, as their leverage multiples during the boom periods and suddenly deleverage to contract significantly during recessions.

Nevertheless, we are yet to find satisfactory answers for the questions such as: (i) Is shadow banking required for an economy? If yes, at what level and what size? (ii) Why is it difficult to bring it under rigorous supervision? What measures are needed for effective supervision? (iii) Is it contributing for financial instability in the financial system? (iv) Do they really support the banking system? (v) When financial inclusion through banking is advocated the world over where is the need for shadow banking? (vi) Does shadow banking really contributes for economic growth through financial intermediation? If yes, at what cost? (vii) Are the activities of shadow banking transparent enough for easier supervision and regulation? and (viii) Is it an efficient mode of financial intermediation for a growing financial system?   


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