The shadow banking system: implications for fi nancial regulation

The current financial crisis has highlighted the changing role of financial institutions and the growing importance of the “shadow banking system” that grew on the back of the securitisation of assets and the integration of banking with capital market developments. This trend has been most pronounced in the United States, but has had a profound influence for the global financial system as a whole. In a market-based financial system, banking and capital market developments are inseparable, and funding conditions are closely tied to the fluctuations of leverage of market-based fi nancial intermediaries. Balance sheet growth of market-based financial intermediaries provides a window on liquidity in the sense of availability of credit, while contractions of balance sheets have tended to precede the onset of financial crises. Securitisation was intended as a way to disperse credit risk to those who were better able to absorb losses, but instead securitisation served to increase the fragility of the financial system as a whole by allowing banks and other intermediaries to leverage up by buying each others’ securities. In the new, post-crisis financial system, the role of securitisation is likely to be held in check by more stringent financial regulation and the recognition of the importance of preventing excessive leverage and maturity mismatch in undermining financial stability.