Shadow Banking System: A Dreadful Challenge!

The world has hardly coped with its latest economic nightmare - financial crisis that started during 2007/08. The conditions now show impressive signs to portray the revival from the crisis but one might not be sure enough as the economic activities follow a cycle. Ben Bernanke in April, 2012 defined Shadow Banking System – “Shadow banking, as usually defined, comprises a diverse set of institutions and markets that, collectively, carry out traditional banking functions--but do so outside, or in ways only loosely linked to, the traditional system of regulated depository institutions. Examples of important components of the shadow banking system include securitization vehicles, asset-backed commercial paper (ABCP) conduits, money market mutual funds, markets for repurchase agreements (repos), investment banks, and mortgage companies.”

Investment banks used the Off-Balance Sheet, Securitization to finance mortgages and their risk was hedged through Off-Balance Sheet Credit Default Swaps before the crisis. But things changed in 2008, when investment banks like Morgan Stanley and Goldman Sachs became the bank holding companies; famous companies like Merrill Lynch and Bear Stearnswere took on by bank holding companies and the most of all, Lehman Brothers declared its bankruptcy. Statistics show that the volume of the Shadow Banking System (SBS) transactions sky-rocketed after 2000 basically, the only reason for it can be the easy access to financial services through the non-official banks, but as long as the intentions were fulfilled, ethics was ignored. According to the Financial Stability Board Report, the volume of SBS transactions has increased to $67 trillion in November 2012 which was about $50 trillion in 2007, so the condition looks very vibrant.

Our region feels no less proud to mention again that we did not get affected much during that crisis. But a thought struck when I read that a company in India took small deposits and promised the payments on land, apartments or the loan interests but finally, neither the staffs of the company got paid nor the 1.74 million people got any promised service. Similarly, China is also coming up with a law to repel the SBS transactions like Off-Balance Sheet loans which will ultimately reduce the reported level of lending. Nepali market recently did go through a news headlines which suggested that the money worth more than NRs. 8 arabs went in vain through the cooperatives and that the regulated banking channel is yet to discover and recover the loan worth NRs. 25 arabs. The first one is a sheer example of SBS transaction and the latter one portraying the inefficient banking regulation.

Few major reasons why SBS transactions have been ignored globally and now nationally are that they have cultural explanations, they are happy enough maintaining low profile and our regulators/government keep high focus on banks and insurance companies. If the negligence continues, poor will become poorer; local and regional economic challenge is inescapable!

Note: This article was published in the Perspectives of The Himalayan Times.