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Shadow Banking System Grows Larger After Financial Crisis

Most experts agree that one of the major causes of the financial crisis was the rise of the shadow banking system, an unregulated sector of financial transactions that often stand in for traditional banking operations. This includes money market funds, insurance products like credit default swaps (as well as much of the unregulated derivatives market), securities lending, repo deals, and other off-balance sheet vehicles used by banks outside of oversight mechanisms, which tend to magnify problems in the financial system in times of crisis.

So you should all be pleased to know that this system has grown in the wake of the 2008 crisis.

The shadow banking industry has grown to about $67 trillion, $6 trillion bigger than previously thought, leading global regulators to seek more oversight of financial transactions that fall outside traditional oversight […]

While watchdogs have reined in excessive risk-taking by banks in the wake of the collapse of Lehman Brothers Holdings Inc. in 2008, they are concerned that lenders might use shadow banking to evade the clampdown. Michel Barnier, the European Union’s financial services chief, is planning to target money market funds in a first wave of rules for shadow banks next year.

The story of the financial crisis concerns a housing bubble that collapsed. But the vast amount of securities trading, many of it in shadow banking forms like this, caused that collapse to escalate and take down firms. To this day, regulators don’t have precise information on a particular financial institution’s exposures to shadow banking vehicles. These are used as much as to hide the true nature of balance sheets from investors and regulators as they are to make money.

Domestic banks already have skillfully avoided most capital requirements from the Basel III accords. But whether or not they eventually lose that battle hardly matters if they can transition to off-balance sheet vehicles in a time of stress and mask their true condition to the public and to the regulatory apparatus.

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David Dayen

David Dayen