Introduction to

Shadow Banking
Components of the Shadow
Banking Industry
1. Hedge Funds
2. Private Equity
3. Loan Shark Operations
4. Pawnshops
5. Peer-to-peer lending between businesses and individuals
6. Money Markets Funds
7. Broker-Dealers
Larger than the World Economy
 Narrow Shadow Banking Assets
Global Financial Assets: $340 Trillion
Narrow Shadow Banking Assets: $45
Trillion

Source: Financial Stability Board

OFIs have grown by
8% to $99 Trillion -
faster than banks,
insurers and
pension funds.
Account for 30% of
the financial
system’s assets; the
highest level since
2002.
Shadow Banking:
A Background
So, Why Don’t
Government Crack
Down?
Shadow Banking
and The Financial
Crisis of 2008
Prior to the Crisis
Ability to profit was limited by:
● Access to capital
● Size of their balance sheet
Securitization
Securitization
 Benefits of Securitization
1. Allows retail investors to buy
i into a large pool of mortgages.
2. Division of Risk
3. Allows creditor to remove
associated assets
from the
balance sheet.
4. Rate of return backed by tangible
goods.
 The Process in brief
Step 1 Step 2 Step 3 Step 1

Win-Win Situation:
Home, General and Securitization through Sale of Securitized
Consumers get cheap
Consumer Loans investment bankers Assets to pension funds,
credit and investors find
hedge funds, etc.
a way to earn higher
returns over Treasuries
with minimal risk.
 The Problem
People tend to
extrapolate
current events
too far into the
future.
 The Problem
Premium investors
required for bearing
credit risk associated
with MBSs, CDOs, etc
were not price
accordingly for the
level of underlying risk.

Spread between Moody’s AAA and US 10-Year Treasury

Source: The Federal Reserve
So, What Went
Wrong?
 US Total Societal Leverage
Total Societal Leverage
(Household, Farm, Corp.
Government and
Financial) - June 2007

Source: Federal Reserve

Federal Funds Rate (Interest Rate)
Global Crude Price $/barrel
Spread between Moody’s AAA and US 10-Year Treasury
Source: The Federal Reserve