Econintersect: Shadow banking refers to those enterprises that perform banking-like functions, i.e. funding risky assets with the traditional banking feature of borrowing short-term and lending long-term. In the extreme case, banks fund loans with demandable assets, with the stability of the process reinforced with government banking regulations. Shadow banking enterprises operate outside of the regulatory structure, in the "shadows". Assets in the "shadows" for the U.S. have declined since the Great Financial Crisis, but the total still exceeds the assets of regulated U.S. banks.
Problems can arise when the operational functions become blurred between regulated banking and shadow banking, and especially when the regulated banks "hide" some of their activities in shadow entities to lighten the capital requirements that would otherwise be enforced on the banks.
Enrico Perotti has written a new Policy Insight for CEPR (Center for Economic Policy Research) which can be viewed below. This paper sharpens the definitions of shadow banking functions and their origins, which have arisen because of the greatly increased use of collateralized lending. The policy paper concludes with the question of whether the increased safe harbor status of many shadow banking entities is wise.
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A Vox.eu article by Perotti presents the background and a summary of the CEPR paper.