Shadow Banking: Parallel and Growing?

In 2007 the sub-prime mortgages started suffering as most consumers were unable to take on the higher mortgages as a result of a higher floating rate. Shadow banks found it tough now to mop funds from the repo market using asset backed securities. This was akin to putting a stop on the main valve of the shadow banking system. To further shake investor confidence came the fall of Lehman Brothers. Foreign investors stopped investing in asset-backed commercial paper. Shadow Banking was on a ‘run.

The world then saw the financial markets unraveling. It is still reeling under the impact of this ‘run’.

“What the world needs right now is a rescue operation. To do this, policymakers around the world would need to do two things: get credit flowing again and prop up spending.”, says American political and economic commentator Paul Krugman.

This brings us to the essential question. How does a nation that employs such strict adherence to its parking fines and speed limits let its financial super power status go to waste? How does it sit by the sidelines and watch as a few players play the market as if it were the wild, wild west. Turning as it were a blind eye to the unscrupulousness of a few while the majority of the tax saving public watches their life’s net worth go down the drain? Shadow Banks alone are not responsible for this crime. Governments and government agencies are also complicit in this offence.

It is time for including banking into the mainstream. It is critical that regulators keep an eye for such high risk players. As a correct step in that direction the Fed has accepted Basel III norms of Tier I capital adequacy ratios. Still there is much more to be done. It is time to go back to an adherence to basics. Investors and market players need to be prudent  and think long term, rather than just short term high risk gains, the ground of shadow banking players.

In conclusion I would like to quote Krugman again who so accurately says “As the shadow banking system expanded to rival or even surpass conventional banking in importance, politicians and government officials should have realized that they were re-creating the kind of financial vulnerability that made the Great Depression possible—and they should have responded by extending regulations and the financial safety net to cover these new institutions. Influential figures should have proclaimed a simple rule: anything that does what a bank does, anything that has to be rescued in crisis the way banks are, should be regulated like a bank.”