The financial system is constantly evolving and becoming more and more complex. A term that often appears in connection with possible risks is shadow banking. However, what suggests shady dealings is nothing more than an extended arm.
Shadow banks are actors in the financial system who work outside of the regulated banking system. These provide services that are also offered by banks. These are usually mutual funds, insurance companies or hedge funds. The benefits are directly related to loans or investments.
How does shadow banking work?
They are usually less regulated than conventional banks, so they can react more flexibly to market changes. However, this has both advantages and disadvantages. For example, shadow banks often act in the securitization of assets. To do this, they buy up various loans, debts and mortgages and then bundle them into new securities. Investors can purchase these in sequence.
This can quickly become a problem when greed becomes excessive. The best example in the recent past was the so-called subprime crisis, which almost led to the collapse of the global financial system in 2008. At that time, shadow banks bought countless real estate loans and used them to create new securities.
A deterrent example of the subprime crisis
Due to the high increases in value, these were also readily bought by Europe’s banks until the market collapsed. The result was countless homeowners who were no longer able to service their loans. After mass auctions, the market collapsed, all investors wanted to get rid of these toxic papers as quickly as possible. The investment bank Lehman Brothers was the most prominent victim of this financial tsunami.
While shadow banks can quickly provide capital and liquidity when needed, this is where the risk lies. If investor money flows out, then they get into difficulties to service their short-term liabilities. This can currently be seen in the real estate crisis in China. Too many apartments are empty, and the companies that have previously raised capital through shadow banks are facing major challenges.
A lack of transparency hides risks
The lack of transparency often only reveals a systemic risk when it is too late, as history has proven. The regulatory authorities are therefore trying to make the activities of the shadow banks more transparent. This is to ensure that problems can be identified at an early stage. This starts with reporting and ends with sufficient capital buffers. Longer notice periods for investors should also rule out a bank run.
Given this, it is little wonder that governments are also trying to reduce the possible risks in the cryptoverse. This includes increased regulation, which also includes new cryptocurrencies such as Wall Street Memes faces regulatory challenges.
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2023-09-02 20:06:31
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