Shadow Banking System - History and Origin of The Term

History and Origin of The Term

The term "shadow banking system" is attributed to Paul McCulley of PIMCO, who coined it at Federal Reserve Bank of Kansas City's Economic Symposium in Jackson Hole Wyoming in 2007 where he defined it as "the whole alphabet soup of levered up non-bank investment conduits, vehicles, and structures." McCulley identified the birth of the shadow banking system with the development of money market funds in the 1970s – money market accounts function largely as bank deposits, but money market funds are not regulated as banks. It should be noted that the term "shadow banking system" is pejorative and carries the connotation that there is something sinister about such non-bank financial institutions when in fact the services provided by shadow banks have been recognized as providing important benefits to the financial system.

The concept of hidden high priority debt dates back at least 400 years to Twyne's case and the Statute of Bankrupts (1542) in the UK, and to Clow v. Woods in the U.S. These legal cases led to the development of modern fraudulent transfer law.

The concept of credit growth by unregulated institutions, though not the term "shadow banking system", dates at least to 1935, when Friedrich Hayek stated:

There can be no doubt that besides the regular types of the circulating medium, such as coin, notes and bank deposits, which are generally recognised to be money or currency, and the quantity of which is regulated by some central authority or can at least be imagined to be so regulated, there exist still other forms of media of exchange which occasionally or permanently do the service of money.... The characteristic peculiarity of these forms of credit is that they spring up without being subject to any central control, but once they have come into existence their convertibility into other forms of money must be possible if a collapse of credit is to be avoided.

The full extent of the shadow banking system was not widely recognised until work was published in 2010 by Manmohan Singh and James Aitken of the International Monetary Fund, showing that when the role of rehypothecation was considered, in the U.S. the SBS had grown to over $10 trillion, about twice as much as previous estimates.