In the latest edition of the Economic Policy Review, authors Zoltan Pozsar, Tobias Adrian, Adam Ashcraft and Hayley Boesky provide a detailed description of the institutional features of the shadow banking system, including insight into its economic role and relation to the traditional banking system. The study, “Shadow Banking,” also includes an estimate of the size of the shadow banking system and observations on the system’s future in light of recent reform efforts. The study is a revised version of a paper the authors published in the New York Fed’s Staff Reports series in 2010.
Shadow banks are financial intermediaries that conduct maturity, credit and liquidity transformation without explicit access to central bank liquidity or public sector credit guarantees. These intermediaries contributed to asset price appreciation and the expansion of credit prior to the financial crisis. During the crisis, however, the system’s vulnerabilities and fragility were exposed, ultimately compelling the Federal Reserve and other government agencies to provide emergency support.
Using the Federal Reserve’s “Flow of Funds” data, the authors calculate that shadow bank liabilities grew to nearly $22 trillion in June 2007. For comparison, the total traditional banking liabilities for the same period were around $14 trillion. However, the size of the shadow banking system has contracted substantially since the peak in 2007, while total liabilities of the traditional banking sector have continued to grow.
Looking ahead, the authors contend that despite efforts to address the excesses of credit bubbles, the shadow banking system will likely continue to play a significant role in the financial system for the foreseeable future. Furthermore, increased capital and liquidity standards for traditional banking entities are “likely to increase the returns to shadow banking activity” partially because reform efforts have done “little to address the tendency of large institutional cash pools to form outside the banking system.”
Zoltan Pozsar is a senior advisor at the U.S. Treasury Department’s Office of Financial Research; Tobias Adrian is a vice president and Adam Ashcraft a senior vice president at the Federal Reserve Bank of New York; Hayley Boesky is a vice chairman at Bank of America Merrill Lynch. Their study can be read in full in the latest Economic Policy Review.