The threats posed by shadow banking are not hard to divine. The sector is rife with sources of instability. Much of the leverage in the US economy grew outside bank balance sheets through securitised loans; networks of derivatives involving non-bank companies amplified systemic risk. As regulators constrain banks’ room for manoeuvre, they must beware of risky behaviour merely migrating to the shadow banking sector where it will be harder to spot.
But with wise policy, the usefulness of shadow banking activities can be greater than the threats. Taming and harnessing non-bank finance rather than smothering it should be the goal of rulemakers.
There is an advantage to having alternatives to conventional banks. It is not coincidental that the US – where banks intermediate less of the financial flows than in the UK or the eurozone – is further ahead in its recovery. If all your financial plumbing is routed through banks, you have a much worse problem when the pipes clog up, as Europe is now learning the hard way.
Non-banks can also offer healthy competition in markets where normal banking is dominated by a few big names. And there are types of financing – with risk and maturity profiles more suited to equity-like relationships than conventional loans – those banks, with their entanglement in the payment system and deposit account provision should steer clear of.
If financial regulation does not spread the light wider, it will only drive more risk into the shadows.
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