Part I Summaries of the seminar

The seminar on “The rise of shadow banking” by Mr. Philippe Delhaise told us about some basic information of shadow banking, like definition, history, different appearances around the world, benefits and potential issues.

Definition

Before talking about shadow banking, we need to know about what is not shadow banking, or traditional banks. Traditional banks provide services like lending, payment, safekeeping of financial assets and so on. Traditional banks have strict regulations for two main reasons: one is to protect its depositors(depositors put their money in the bank instead of other place because they incapable to protect their assets or the transaction cost of traditional bank is relatively low compared with other institutions providing more secure service), while how much the bank can protect its depositors depends on many factors, such as, whether the bank itself is strong enough(whether it has enough reserves or strong backup), the deposit guarantees schemes or even whether the government will provide emergency aids to the banks. Another is to control the supply of money, which is also used by the central government to maintain its monetary policy. The governments want to control the supply of money because when bank lends out money, it will create a spiral of money. Once the government lose control of the supply of money, overheating in economy or inflation may occur (for too much money supply and too little money supply, respectively).

Shadow banking does not mean underground banking or illegal transaction. There’re different definitions about shadow banking, simply speaking, shadow banking is some institutions lend money without being licensed to do so. The Financial Stability Board defined shadow banking as “credit intermediation involving entities and activities outside of the regular banking system”. That is, shadow banking provides channel without regulations from the government, or more market-based. The key difference between shadow banking and traditional banks is which party will take the financial risk when the borrower default.