Chapter 1: Decoding shadow banking: a primer
The shadow banking system attracted little attention before the latest global financial crisis which began in 2007 but turned out to be one of the main causes for “the worst financial crisis since the Depression”. It was plausibly claimed that the global financial crisis started as a liquidity run on the repo market, which was categorized as one of the most important sectors in the shadow banking system. There are two schools of thought explaining the cause of the recent financial crisis. According to the global savings glut theory, it was high savings which fueled flows of money from emerging market economies and pushed long-term interest rates down to rock-bottom levels, leading to asset bubbles in the United States and other countries. By contrast, the global credit glut theory diagnosed the illness in an opposite way: it was the scale of global shadow banking that caused the trouble. The FSB indicates that, during the period from 2002 to 2007, the shadow banking system increased by US$33 trillion, more than doubling in asset size from US$27 trillion to US$67 trillion. This is 8.5 times higher than the total US current account deficit of US$3.9 trillion during the same period. It is estimated that the shadow banking system is around 25 to 30% of the global financial system and 50% of total global banking assets. It was said that the volume of credit intermediated by the shadow banking sector was just as large as the volume of credit intermediated by the traditional banking system on the eve of the financial crisis. The shadow banking sector has been booming since the onset of the global financial crisis in 2007 with a total amount of US$67 trillion worldwide in 2012. In early 2008, the size of shadow banking was US$20,000 billion while the traditional banking system was US$11,000 billion. Various attempts have been made to estimate the size of shadow banking. It has been estimated that non-bank financial intermediation accounts for 50% of banking system assets and 120% of GDP. Due to the lack of transparency and the breadth and diversity of shadow banking itself, a precise assessment of the size of shadow banking may be a mission impossible.