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Abstract
This paper purports to show that a very specific theory of money underlies the way in which shadow banking is understood by most economists as well as the regulatory changes that arises from their understanding of the phenomenon. It demonstrates that the “shadow banking” metaphor implicitly relies on an erroneous conception of banking according to which banks are mere intermediaries of loanable funds. An alternative conception of shadow banking is proposed, based on the theory of endogenous money, where banks play a unique and very special role. The paper provides another comprehension of the purpose of the shadow banking system within the overall financial system, which leads to quite different regulatory proposals.
Notes
1 The term was coined by Paul McCulley (Citation2007).
2 The Financial Stability Board uses the assets of OFIs as a broad measure of the size of the shadow banking system. “OFIs (or Other Financial Intermediaries) are comprised of all financial institutions that are not classified as banks, insurance corporations, pension funds, public financial institutions, central banks, or financial auxiliaries” (Financial Stability Board Citation2016, 2). The FSB then narrows the focus on non-bank financial entities that may pose financial stability risks (narrow measure).
3 Shadow banking definitions are either based on activities, entities or instruments (Nabilou and Pacces Citation2018).
4 In our view, this may explain why “shadow banking” is so hard to define. It is a vague and poorly delineated concept: if banks are mere intermediaries, any unregulated (or lightly regulated) non-bank financial intermediary can potentially be considered as a shadow bank.
5 These entities are not explicitly listed by McCulley. He only focuses on the institutions that get funded by issuing commercial paper (e.g., Structured Investment Vehicles or Asset Backed Commercial Paper Conduits).
6 Namely the financial intermediation theory and the fractional reserve theory (Jakab and Kumhof Citation2015; Werner Citation2016).
7 Many central banks economists published papers that explicitly reject these theories (Jakab and Kumhof Citation2015; McLeay, Radia, and Thomas Citation2014). Post-Keynesians have long held the credit theory of money (Lavoie Citation2014, chap. 4).
8 This view has been adopted by the Financial Stability Board (Citation2016, 1) which defines shadow banking as “credit intermediation involving entities and activities (fully or partially) outside the regular banking system”.
9 This example is inspired by Claessens et al. (Citation2012). We also added the asset and funding flows, as in Pozsar et al. (Citation2012).
10 The intermediation chain is usually longer. A more realistic representation of the shadow credit intermediation process can be found in Pozsar et al. (Citation2012).
11 On 22 October 2018, the Financial Stability Board (Citation2019, 9) declared that it would replace the term “shadow banking” by “non-bank financial intermediation”.
12 In the conclusion of his seminal paper, Pozsar (Citation2013, 306) argues that “if regulatory arbitrage inspired the pejoratively-sounding term shadow banking, cash portfolio diversification could imply renaming it to market-based banking”.
13 This approach has been picked up by major regulatory bodies such as the Financial Stability Board that seeks to transform shadow banking into “resilient market-based finance” (Financial Stability Board Citation2015).
14 By offering to buy and sell assets at certain prices, dealers provide market liquidity (Mehrling et al. Citation2013, 10).
15 Several runs occurred during the Global Financial Crisis. The most significant runs occurred in the ABCP market, the repo market and on MMMFs.
16 The backstop was either explicit (credit lines provided to off-balance sheet vehicles) or implicit (taking shadow banks with which they had no explicit commitments on their balance sheets to mitigate reputational risk).
17 According to Google Scholar, this paper has been quoted 547 times as of April 2019 and arrives in second position in terms of citations when one uses the keywords “shadow banking”.
18 Gorton and Metrick (Citation2010, 288) argue that minimum haircuts would be used “as an analogue to capital requirements” and that it would “limit leverage and reduce rehypothecation”. It must be noted that in another paper, the same authors argue that the repo haircut is analogue to the reserve requirements because it “forces banks to keep some fraction of their assets in reserve when they borrow money through repo markets” (Gorton and Metrick Citation2012, 427).
19 This distinction between finance (initial finance) and funding (final finance or saving) has been used by several post-Keynesians (Davidson Citation1986; de Carvalho Citation2016; Graziani Citation2003, 69–74). It can be traced back to Keynes’ articles published in the Economic Journal between 1937 and 1939 (Keynes Citation1937a, Citation1937b, Citation1939; Keynes and Robertson Citation1938).
20 This assumption (other agents have an account with the same bank) will hold for the rest of the section. Adding several banks would not add anything, except complexity.
21 Pozsar et al. (Citation2012) identified three sub-systems that form the shadow banking system. The internal sub-system corresponds to Financial Holding Companies (FHC) while the external sub-system is composed of diversified broker-dealers and of a range of independent non-bank financial institutions such as standalone finance companies or asset managers. The government-sponsored enterprises (GSEs) constitute the government-sponsored sub-system.
22 Some post-Keynesians disagree with this traditional post-Keynesian perspective (Nersisyan and Dantas Citation2017). Instead, they propose to think in terms of liquidity creation and argue that both banks and NBFIs create liquidity.
23 MMMF shares are not debt securities but equity. They can however be considered as another layer of debt in this example because of their specificities (they can be redeemed on demand and they maintained a stable Net Asset Value until the crisis).
24 See Appendix 1 for more details on the specific case of Perry Mehrling.
25 There is also a second intermediary (Derivative Dealer) in the model. The idea is that the shadow bank uses various swaps to hedge its risk and turn its risky security (RMBS) into a quasi-Treasury bill that can be used as collateral to borrow from the MMMF.
Additional information
Notes on contributors
Rudy Bouguelli
Rudy Bouguelli is a member of the CEPN, Université Paris 13 - Sorbonne Paris Cité. The author would like to thank Marc Lavoie and Bernard Guerrien for helpful comments.