Monday, January 16, 2012

The shadow banking system as savior

The shadow banking system, non-bank lending institutions, was viewed as a problem in the 2008 crisis, yet now it may serve as the savior of the financial markets. Shadow banking is now back to pre-2008 levels and as banks exit markets, it is the shadow system of private equity, hedge funds, and money market funds, which is offering lending facilities. 

Regulators and policy-makers want banks to shrink but lending is till the life blood of any economy, so there will be new institutions to take the place of banks. Banks have a high cost structure and are not able to make their spreads given the flattening of the yield curve. Shadow financial intermediaries are not subject to Dodd Frank and Basel III. 

In the short-run, this will serve as a safety value for those who need funds, but in the longer-run, regulators may lose the control that they desire. 

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