Still think the financial crisis happened at banks? Think the extensive regulation of banks that Congress and regulators have undertaken since 2008 has solved the problem?
Take a look at this chart from “Shadow Banking Reemerges, Posing Challenges to Banks and Regulators” by analysts Alex Musatov and Michael Perez at the Federal Reserve Bank of Dallas, published in their July Economic Letter.
Here’s what economist and blogger Timothy Taylor has to say about this chart:
Notice that before the financial crisis in 2008, liabilities of banks don’t soar; after the crisis, they don’t fall. The financial crisis instead happened in the shadow banking sector, where you can see the sharp rise in liabilities before the crisis circa 2008 and the sharp fall afterwards.
The basic lesson here is that if you still think banks are the core representative institutions in the financial system of high-income economies, you are a few decades out of date. If you are concerned about the dangers of financial sector risks cartwheeling into the real economy, you need to think about the shadow banking sector.
In the Federal Reserve report, the analysts take a look at the players in the shadow banking market, their interconnections with traditional banks, their value to the economy and their potential for causing trouble.
Their key points:
Shadow banking has come roaring back and in new forms that still manage to escape bank regulation and could pose systemic risks since these activities remain deeply intertwined with traditional banking.
Known for swiftly evolving and adapting to new regulations and changes in investor preferences, NBI may be taking on risky activities with few restraints. (Editor’s note: “NBI” stands for “nonbank intermediation,” which is what these Fed analysts call shadow banking.)
They conclude that regulators are watching shadow banking more now, but:
Still, many areas of NBI remain obscured from regulators’ view, and not all NBI is subject to supervision. The main challenge for policymakers is creation of macroprudential oversight while simultaneously maximizing the benefits of NBI and minimizing its contribution to systemic risk.