Jun 24

Shadow Dancing With the Global Financial System

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“Do it light , taking me through the night
Shadow dancing , baby you do it right
Give me more, drag me across the floor
Shadow dancing , all this and nothing more”

–      Lyrics by Andy, Barry, Maurice and Robin Gibb (aka The Bee Gees)

When the brothers Gibb penned this song they undoubtedly had no reason to think of the banking system, unless it was where to invest their enormous royalties.

However, the shadow banking system is once again on a growth path that will continue to: (1) create havoc with the ability of regulators to control systemic risk and (2) make it very difficult to anticipate financial market conditions.

Consider this analysis from the Federal Reserve Bank of New York.

(By the way, it is just one of several educational resources you will find at InsurerCIO.)

Put simply, the analysis does a terrific job of describing the shadow banking system and its numerous tentacles.  I think you will be surprised to see how deep and broad this system is in the US alone.

Over in the second largest economy in the world, the Chinese government is concerned with the growth of their own shadow banking system and how it has encouraged the expansion of credit at a faster pace than the government would like to see.  In fact, curtailing shadow banking in China is having the expected impact of slowing the pace of growth.  And as China sneezes, many countries (and commodities) are experiencing various secondary impacts.

Meanwhile, back in the USA, I would recommend that you take a look at the numerous graphical appendices from the FRB report.  You may think in the post-financial crisis, the shadow banking system has shrunk and is virtually non-existent, subject to numerous new regulations, market forces, etc.  Think again, when you review this schematic.

From a distance it looks like a complicated integrated circuit board (please make sure to keep ‘zooming in’ to see the details).  And, that, perhaps is the best analogy for the shadow banking system in the US.

You see, the shadow banking system is deeply integrated into the economy and financial markets.  And, it will continue to grow, as regulatory strictures, such as increased capital requirements, a version of the Volcker rule, etc. are imposed on regulated (non-shadow) banking entities.

Will the shadow banking system be a contributing cause to the next financial crisis, whenever it might occur?  We shall see.

Perhaps the shadow banking system can best be characterized by the opening of the old time radio show, “The Shadow”.