As progress has been made in reforming the global banking system and as risk appetite returns to financial markets, wider attention has begun to focus on shadow banking.
That focus is not new for policy makers. Reform of shadow banking – the extension of credit from entities and activities outside the regular banking system – has been a core part of the Group of 20’s agenda to overhaul the global financial system since the 2009 Pittsburgh summit, when, in response to the crisis, leaders established the Financial Stability Board. The aim has been to deliver a transparent, resilient, sustainable source of market-based financing for real economies.
In the run-up to the crisis, opacity in shadow banking fed an increase in leverage and a reliance on short-term wholesale funding. Misaligned incentives in complex and opaque securitisation structures weakened lending standards. Securities financing markets fed boom-bust cycles of liquidity and leverage. Ample liquidity and low volatility drove increasing availability of secured borrowing. That created a self-reinforcing dynamic of more leverage, even greater liquidity, lower volatility and even greater access to secured borrowing. When confidence evaporated, that process went sharply into reverse. Markets seized up, investment vehicles – the size of which had tripled in the three years before 2007 – failed, and money market funds experienced runs.