Shadow Banking and the unintended consequences of QE and other central bank policies

First of all, let’s try to understand a bit more what is Shadow Banking:

http://www.investopedia.com/terms/s/shadow-banking-system.asp

Definition of ‘Shadow Banking System’

The financial intermediaries involved in facilitating the creation of credit across the global financial system, but whose members are not subject to regulatory oversight. The shadow banking system also refers to unregulated activities by regulated institutions.

Investopedia explains ‘Shadow Banking System’

Examples of intermediaries not subject to regulation include hedge funds, unlisted derivatives and other unlisted instruments. Examples of unregulated activities by regulated institutions include credit default swaps. 

The shadow banking system has escaped regulation primarily because it did not accept traditional bank deposits. As a result, many of the institutions and instruments were able to employ higher market, credit and liquidity risks, and did not have capital requirements commensurate with those risks. Subsequent to the subprime meltdown in 2008, the activities of the shadow banking system came under increasing scrutiny and regulations

Wiki also comes up with a good overview: http://en.wikipedia.org/wiki/Shadow_banking_system

 

What is important to keep in mind is that Central Banks  (the FED is the champion of the QE cause) are very keen in maintaining a good quality of  their balance sheet and for this purpose…. they acquire only best quality assets.  The consequences of buying junk assets could be disastrous and lead to a loss of credibility which could translate into a currency crisis.

I came across quite a few articles and info regarding the importance of shadow banking and in fact… it is very difficult to really estimate the market size of this “animal”. What we can assess is that it is in fact VERY VERY VERY LARGE. (10s of trillions of USD). However… its importance has grown a lot during the last 20 years and has become a central piece of the credit market. It has also been a central piece of the 2008-2009 maket meltdown and it is quite amazing how misunderstood still… this market is for most of us.

One of the principal charateristic of Shadow Banking is to feed on collateral !  Today…. the fight of the giants is for good quality collateral and Central Banks directly compete with the needs of the Shadow Banking. Ellen Brown  in her writing : Collateral Damage: QE3 and the Shadow Banking System | WEB OF DEBT BLOG   has written a very good piece about the unintended consequences of QE among  quite a few others (just search  shadow banking collateral  on the internet if you are interested) .  The fact are that balance sheet asset expansion by central banks compete with the market place and distort asset prices and market behaviour. QE is one form, the SNB CHF/EUR pegg is another one etc… and all want good quality asset (usfelul collateral)

it is amazing to observe that even with the credit spreads compression across the board we have witnessed until Q1 2013…. credit expansion has remainded very tame. Credit demand is constraint and willingness to lend with lower quality collateral is also a problem.  JPM London Whale was maybe  just the tip of the iceberg of desperate institutions trying to increase their ROI as …. unintended consequences of policy makers who do not really understand what the real life is.

Once more…. watch out with whom you bank ( https://relativemoney.wordpress.com/2013/09/10/select-where-and-with-whom-you-wanna-bank/ )

 

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One thought on “Shadow Banking and the unintended consequences of QE and other central bank policies

  1. Pingback: Shadow banking and collateral | Relativemoney's Blog

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