TheLure of Shadow Banking Byanonymous At http://www.economist.com/news/leaders/21601826-shadow-banks-helped-cause-financial-crisis-better-regulated-they-could-help-avert-next Shadow banks helped cause the financial crisis. Betterregulated, they could help avert the next one. 1. Mark Carney, governor of the Bank of England and head of the FinancialStability Board (FSB), an international watchdog set up to guard against future financial crises , was recently asked to identify the greatest danger tothe world economy. He chose shadow banking in the emerging markets .Shadow banking certainly has the credentials to be a global bogeyman. It ishuge, fast-growing in certain forms and little understood—a powerful tool forgood but, if carelessly managed, potentially explosive. 2. The FSB, which defines shadow banking as lending by institutions otherthan banks, reckons it accounts for a quarter of the global financial system,with assets of $71 trillion at the beginning of last year, up from $26trillion a decade earlier. In some countries, shadow banks are expanding evenfaster: in China, for instance, they grew by 42% in 2012 alone. 3. But there is disagreement about what counts as shadow banking. The coreis credit (everything from China’s loan-making trust companies toWestern peer-to-peer lending schemes and money-market funds). A broaderdefinition, however, would include any bank-like activity undertaken by a firmnot regulated as a bank: think of the mobile-payment systems offered byVodafone, the bond-trading platforms set up by technology firms or the investmentproducts sold by BlackRock. 4. As our special report explains, services like these areproliferating because orthodox banks are on the back foot, battered by lossesincurred during the financial crisis and beset by heavier regulation, highercapital requirements, endless legal troubles and swingeing fines. The banks areretrenching, cutting lending and shutting whole divisions. In America, forinstance, investment banks are no longer allowed to trade on their own account,only on behalf of clients. British banks, meanwhile, have slashed their loansto businesses by almost 30% since 2007, with Barclays this week confirmingplans to shed up to 14,000 staff. Shadow banks are filling these gaps. Frailty, thy name is bank 5. Nobody is too worried by competition to banks in their ancillarybusinesses: if, say, Google can help people manage their money more efficiently,that is to be welcomed. The argument is about credit. In some ways, it is agood thing that lending outside the banking system is expanding. Banks areregulated for a reason: they have big “ maturity mismatches ” (borrowingmoney largely for short periods while lending it out for the longer term),enormous leverage and are tangled up in complicated ways with otherfinancial institutions, so they are especially fragile. And when they get intotrouble, taxpayers tend to end up on the hook, because governments bothguarantee deposits and are frightened to let such big and complicatedinstitutions fail. So if some lending is moving from banks to less dangerousentities, the financial system should be safer. 6. For these reasons, Mr. Carney should be happier if, say, a Britishbrewer takes a long-term loan from a pension fund or a life insurer withlong-term liabilities instead of from a bank. If the loan goes wrong,the creditor will lose money, but without the gelignite of leverage, theelaborate web of counterparties and the depositors demanding their money now,losses in one institution are less likely to damage others. 7. Yet shadow banks, if poorly regulated, can be just as dangerous as thebetter-lit sort. One of the principal culprits in the financial crisis was the“structured investment vehicle”, a legal entity created by banks to sell loansrepackaged as bonds. These were notionally independent, but when they got intotrouble they pulled in the banks that had set them up. Another source ofinstability were money-market funds, through which firms and individualsinvested spare cash for short spells. These had been thought of as risk-free.When it became apparent that they were not, they suffered a run. China’s dark money 8. The disaster taught regulators useful lessons. The shadow banks thatcaused the biggest problems had either big maturity mismatches or not enoughcapital to absorb losses. Most troublesome of all were those whose difficultiesinfected the banks, because the banks had either lent them money or hadprovided them with a backstop of some kind. Not surprisingly, the shadow banksthat were created solely to take advantage of a less exacting regulatory regimeturned out to be just as fragile and dangerous as banks. 9. New regulations in many countries aim to make such shams impossible.Banks must now incorporate structured investment vehicles on their balance-sheets ,for instance. Money-market funds must hold more liquid assets, to guard againstruns. Limits on leverage have been imposed or are being considered for manyforms of shadow bank. 10. Yet as Mr Carney’s anxieties suggest, the job of making shadow bankssafe is far from complete. For instance, American regulators are still allowingsome money-market funds to create the impression that an investor can neverlose money in them. They should be forced to be more honest. 11. But the bigger danger lies in China, where regulatory arbitrage ishappening on an alarming scale. Banks there are banned from expanding lendingto certain industries, and from luring deposits by offering high returns. Sothey do both of these things indirectly, through shadow banks of various sorts.Meanwhile, some firms are setting themselves up as pseudo-banks: one shipyardmakes a third of its money from finance (see article ). It is hard to imagine that all the shadowy loans tounprofitable steel mills and overextended property developers will pay off. Yetinvestors are being encouraged to pile in by a series of bail-outs that have sofar shielded them from most of the harm when such loans have soured. 12. This is a crisis in the making. It will not bring China down—thegovernment can use state-owned banks to temper its effects, and it has enoughcash to spend lavishly to set things right. But it could still cost a lot. Thesooner the regime spells out which assets are protected, the sooner investorswill take more care about risk. Shadow banking can make finance safer, but onlyif it is clear whose money is on the line. Reading Comprehension Decide whether the followingstatements are true (T) or false (F). 1. Mark Carney believes that the greatest danger to the world economy isthe shadow banking in developed countries . 2. Broadly speaking, shadow banking includes any bank-like activity by anonbank, such as loan-making by trust companies and bond-trading platforms,etc. 3. The boom of shadow banking is partly because traditional banks areseriously hit by financial crisis. 4. Banks become safer when they have big “maturity mismatches” andenormous leverage. 5. “Structured investment vehicle” was one of the causes of the 2008financial crisis. 6. Shadow banks pose fewer challenges when they have big maturitymismatches, inadequate capital, and complex relationship with traditionalbanks. 7. Stricter regulations are imposed on banks and shadow banks after thelessons of the financial crisis. 8. The possible another financial crisis that is in the making is able tobring China down because China has too much shadow-banking capital. The Lure of Shadow Banking.docx