A must read for anyone concerned with systemic risk issues to factors impacting asset class return and anyone interested in a comprehensive primer on the operation of today’s money markets. As the following two quotes surmise, the shadow banking sector has developed to the extent it has by virtue of certain structural economic imbalances and financial system checks and balances are not set up to manage the risks of this new plumbing.
one way to interpret shadow banking is as the financial economy reflection of real economy imbalances caused by excess global savings, slowing potential growth, and the rising share of corporate profits relative to wages in national income.
From a policy perspective, the fundamental problem at hand is a financial ecosystem that has outgrown the safety net that was put around it many years ago. Today we have a different class of savers (cash PMs versus retail depositors), a different class of borrowers (risk PMs to enhance investment returns via financial leverage versus ultimate borrowers to enhance their ability to spend via loans) and a different class of intermediaries (dealers who do securities financing versus banks that finance the economy directly via loans) to whom discount window access and deposit insurance do not apply.
The document also discussed the need to have better measures of “money supply” than the narrow money measures of insured deposits.
I for one am concerned over the large shadow banking cash pools and the financing mechanisms of today’s repo markets. At the top of my mind is a large question mark over the interplay between QE and today’s money/collateral/derivatives markets and the impact monetary tightening will have on the shadow banking system.
Some useful references
The Economics of Shadow Banking Manmohan Singh (2013)
Shadow Banking (New York Fed)
The Macroeconomics of Shadow Banking (Aug 2013)