Shadow Banking

Shadow banking refers to the system of credit intermediation that involves entities and activities operating outside the traditional, regulated banking sector. The term was coined by economist Paul McCulley at the 2007 Jackson Hole symposium to describe non-bank lenders that performed maturity, credit, and liquidity transformation similar to commercial banks but without access to central bank liquidity or public sector credit guarantees.

Typical shadow banking entities include money market funds, hedge funds, structured investment vehicles (SIVs), asset-backed commercial paper conduits, securitization vehicles, repo markets, and finance companies. These actors fund long-term, often illiquid assets using short-term liabilities, replicating the core economic function of banks while avoiding capital requirements, reserve ratios, and deposit insurance schemes.

Shadow banking became a central concern after the 2007–2008 global financial crisis, when the collapse of structured credit products and a run on the repo market amplified systemic stress. The failure of Bear Stearns (March 2008) and Lehman Brothers (September 2008), along with the breaking of the buck by the Reserve Primary Fund, demonstrated how shadow institutions could trigger contagion across regulated banks.

In response, the Financial Stability Board (FSB) was tasked by the G20 with monitoring the sector and now publishes an annual Global Monitoring Report on Non-Bank Financial Intermediation (NBFI), the FSB's preferred replacement term for "shadow banking." The FSB has estimated the narrow NBFI measure at tens of trillions of dollars globally, with significant growth in jurisdictions including the United States, the euro area, and China.

Policy responses have included:

• Money market fund reforms by the US SEC (2014 and 2023 amendments) and the EU's MMF Regulation (2017).
• Basel III rules constraining bank exposures to shadow entities.
• Enhanced repo market transparency and central clearing initiatives.

Despite reforms, regulators continue to flag risks from leverage, liquidity mismatches, and interconnectedness, particularly in open-ended funds and private credit markets.