Boom in shadow banking is a stability problem

The FT is pointing out that the European Central Bank (ECB) is worried about the shadow banking boom (intermittent paywall) in Europe.

Ten years after the world was rocked by an unprecedented banking crisis, policymakers are sounding the alarm about the spread of risk out of the now more regulated banks and into the “shadows” where asset managers, insurers and others carry out bank-like business.

The ECB is suggesting that the stringent controls on ordinary banks have led to big investment funds seeking opportunities elsewhere.

The article continues:

Spurred by ultra-low interest rates and quantitative easing, investors have been ploughing funds into asset managers that might be able to generate better returns than pitiful risk-free rates. As a result equities, junk bonds, real estate and many more asset classes are in bubble territory in large parts of the world.

The last is certainly true.

I learn, too that in 2011, the G20, ordered the Financial Stability Board, (no I’d never heard of it either, but it is chaired by a certain Mark Carney) which, supervises global financial rule-making, to come up with an assessment of non-bank finance, which, after much lobbying by the non-bank finance operators concluded there was no real problem!  Yet, Black Rock, the world’s largest fund manager manages assets of $6.3 trillion, which is about five times its size in 2008.

Paul Tucker of the Bank of England stated in 2012 “Anyone with a securities portfolio can build their own shadow bank by borrowing at call against the securities and then employing the cash in credit assets.” Credit assets are loans to you and me – they are assets to the lender – the borrower has the liability and doesn’t even get a mention.

This is a summary of shadow banking.  Its members are a motley crew, delightfully defined above as “asset managers, insurers and others” – the others include hedge funds and ‘structured investment vehicles’, and Mutual Funds (aka MMMF – see below) “which all can carry out bank-like business.” Whilst they do act as intermediaries between lenders and borrowers, by using ‘Money Market Mutual Funds’ they can actually create money (I’ve seen the figures, it’s complex – but they can). It is here we end up with credit default swaps and collateralised debt obligations, asset backed securities and derivatives, of which we have all heard. Some suggest that they may be as much as a quarter of the global financial system and they were certainly rumoured to be greater than that in the US itself in 2008. In 2016, it is alleged that 50% of US mortgages were originated by non-banks.

So, a government that is cutting back and borrowers who are all still impecunious with flat earnings but more and more money created in order to chase the fat returns that ultimately should be available to lenders….

Nothing to worry about in all this, Mr Carney, is there?

And another thing, ‘shadow banking’ was a problem in 2008 yet Positive Money (PoMo) seems still to suggest that all money should be created by the Bank of England. In so doing, they have completely ignored shadow banking, which we can rest assured would flourish even more powerfully when the Bank of England thought that it was creating all the money.

Of course we could have the Bank of England as the ultimate insurer rather than a money creator but for PoMo this is not even on their radar.

Not only is shadow banking still a considerable risk to the world’s financial stability PoMo, as one of the prime movers for financial change seem, regrettably, to have way too much in common with the Bank of England governor.



  1. Bruce Gray -

    Hyman Minsky famously stated that “Anyone can create money, the key is getting someone to accept it”. Money is created the moment one person accepts the debt of another, thereby creating both a debt holder and an asset holder in the transaction. Money also takes many forms: currency, reserves, IOU’s, bank deposits, government or corporate bonds, and others including credit default swaps and collateralized debt obligations.

    There is a hierarchy of money “things” depending on the risk associated with the debt, with government issued debt (currency, reserves, bonds) having the lowest risk, being at the top of that hierarchy. The acceptance of “money things” is based on the risk vs. reward and the ability to convert to lower risk forms of money (i.e. government reserves or currency). People accept commercial bank debt all of the time in the form of demand account deposits because they know it can be converted to government currency “on demand” just by going to the local ATM.

    With greater risk, of course, comes greater rewards or returns. This is a natural state of affairs in a capitalist economy. The problem of course is the constant drive of the financial sector to seek ever increasing returns and thereby increasing levels of risk taking. Left unchecked or unregulated, this invariably leads to market destabilization and potentially collapse; i.e. a “Minsky Moment”. The free market capitalists argue that markets are “rational” and would never take on undue risk and therefore don’t need to be regulated (the GFC of course was just an “anomaly”).

    The problem of course is the concept of “too big to fail”, which means the financial sector knows that if their “bets” go south, the central banks will come in to bail them out, leaving the debt holders out to dry. This belief in the privatizing of profits and socializing of losses still has a strong hold on London and Wall Street and is a key driver of the reckless risk taking we continue to witness. I am afraid it may only be a matter of time before the next “Minsky Moment” arrives.

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