A primer on shadow banking

Bryan Noeth and Rajdeep Sengupta write this nice short primer on shadow banking.

They explain nicely the liabilities and assets of the shadow banks and how they are similar and different from traditional commercial banks.

They sum the note saying  though shadow banks are partly responsible for the crisis, they are still useful for the variety they bring to the financial system.

The reader may question the rationale behind the development of the shadow banking system and all its components. While some analysts have asserted that the shadow banking system is redundant and inefficient, it is not difficult to see the benefits of securitized banking. Securitization allows for risk diversification across borrowers, products and geographic location. In addition, it exploits benefits of both scale and scope in segmenting the different activities of credit intermediation, thereby reducing costs. Moreover, by providing a variety of securities with varying risk and maturity, it  provides financial institutions opportunities to better manage their portfolios than would be possible under traditional banking. 

Finally, and contrary to popular belief, this form of banking increases transparency and disclosure because banks now sell assets that would otherwise be hosted on their opaque balance sheets. In summary, the shadow banking system can be viewed as a parallel system—one that is a complement to and not a substitute for traditional banking. The challenge going forward is to harness the benefits and mitigate the risks and redundancies of such a parallel banking system.

 A nice crisp read…

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