What is the shadow banking system and should it be regulated?

The main difference between traditional banking and the shadow banking system is that the latter are not subject to the same regulatory requirements that apply to traditional banks. Traditional banks in most countries are regulated by the central bank – RBNZ in New Zealand, Federal Reserve in the USA. The shadow banking sector are not structured or regulated as banks and include: investment management companies, pension funds, hedge funds, money market funds, mutual funds, payday lenders and others. However they still offer the same activities as traditional banks – loans, deposit taking etc. See graphic below from Better Markets.

Because of the fact that there is so little regulation the shadow banking sector has been growing and since the GFC in 2008 their share of global financial assets has grown form 42% to 50% by 2020. Therefore the shadow banking sector should no longer continue to be as unregulated. In the traditional banking system stringent capital and liquidity requirements as well as deposit insurance which makes them less susceptible to panic. However the recent collapse of SVB showed how poorly regulated it was and bank credit contracted $311 billion—or 1.77% in just two weeks The main concern with shadow banking is that because there is little regulation they take on more risk which means greater tendency to have less liquidity in reserve and more exposure to debt. On the flip side, shadow banks can offer a broader range of borrowing options which many industries now rely on for financing.

Source: Better Market – March 24, 2022 The Increasing Dangers of the Unregulated “Shadow Banking” Financial Sector

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