Shadow Banking System

The shadow banking system is the collection of non-bank financial intermediaries that provide services similar to traditional commercial banks. It is sometimes said to include entities such as hedge funds, money market funds and structured investment vehicles (SIV), but the meaning and scope of shadow banking is disputed in the academic literature. Investment banks as well as commercial banks may conduct much of their business in the shadow banking system (SBS), but most are not generally classed as SBS institutions themselves. At least one financial regulatory expert has said that regulated banking organizations are the largest shadow banks.

The core activities of investment banks are subject to regulation and monitoring by central banks and other government institutions - but it has been common practice for investment banks to conduct many of their transactions in ways that don't show up on their conventional balance sheet accounting and so are not visible to regulators or unsophisticated investors. For example, prior to the financial crisis, investment banks financed mortgages through off-balance sheet securitizations (e.g. asset-backed commercial paper programs) and hedged risk through off-balance sheet credit default swaps. Some experts have said that regulated banking organizations are the largest shadow banks. No major investment banks exist in the United States other than those that are part of the regulated banking system. (In 2008, Morgan Stanley and Goldman Sachs became bank holding companies, Merrill Lynch and Bear Stearns were acquired by bank holding companies, and Lehman Brothers declared bankruptcy.)

The volume of transactions in the shadow banking system grew dramatically after the year 2000. Its growth was checked by the 2008 crisis and for a short while it declined in size, both in the US and in the rest of the world. In 2007 the Financial Stability Board estimated the size of the SBS in the U.S. to be around $25 trillion, but by 2011 estimates indicated a decrease to $24 trillion. Globally, a study of the 11 largest national shadow banking systems found that they totaled to $50 trillion in 2007, fell to $47 trillion in 2008 but by late 2011 had climbed to $51 trillion, just over its estimated size before the crisis. Overall, the world wide SBS totalled to about $60 trillion as of late 2011. In November 2012 Bloomberg reported on a Financial Stability Board report showing an increase of the SBS to about $67 trillion. It is unclear to what extent various measures of the shadow banking system include activities of regulated banks, such as bank borrowing in the repo market and the issuance of bank-sponsored asset-backed commercial paper. Banks by far are the largest issuers of commercial paper in the United States, for example.