Institute for Financial Transparency

Shining a light on the opaque corners of finance


Shadow Banking Comes Under Fire

In a recently released report, the US Treasury confirmed its membership in the Opacity Protection Team and attacked the use of the term “shadow banking”.

FSB reports and other reports often use the term “shadow banking” to describe credit interme­diation involving entities and actitivities (fully or partly) outside of the regular banking system. Notwithstanding the inclusion of a footnote disclaimer that appear in select FSB documents, Treasury prefers to transition to a different term, “market based finance.” Applying the term “shadow banking” to registered investment companies is particularly inappropriate as the word “shadow” could be interpreted as implying insufficient regulatory oversight, or disclosure.

(Footnote:  The standard footnote, as used in the FSB’s 2016 Shadow Banking Monitoring Report states that: “The FSB defines shadow banking as ‘credit intermediation involving entities and activities (fully or partly) outside of the regular banking system.’ Some authorities and market participants prefer to use other terms such as ‘market­ based finance’ instead of ‘shadow banking.’ The use of the term ‘shadow banking’ is not intended to cast a pejorative tone on this system of credit intermediation.)

I like the term “shadow banking” not because it is a pejorative, but because it highlights the opacity of the activity in this area.  The term ‘market based finance’ intentionally hides the opacity.

Regular readers will recall it is the opacity in the shadow banking system that was at the heart of the Great Financial Crisis.  Specifically, it was the opacity in structure finance securities that hid the true risk of subprime mortgage-backed deals and made these deals impossible to value once the story supporting the valuation collapsed.