Explanation Of Shadow Banking System: How Invisible Players Manipulate Money And Banking Systems

In earlier articles we discuss several proposals for monetary reform such as full reserve banking, and gold standard systems.

Most of these proposals focus on abolishing the fractional reserve lending system used by traditional banks; however, this is not the only cause of financial instability in Canada and elsewhere.

In addition to the traditional banking system, there is also another banking system referred to as the Shadow Banking System.

This article analyzes the shadow banking system in greater detail.

Shadow Banking System

The shadow banking system consists of various financial institutions such as money market funds, private equity funds, hedge funds, securitizations, and investment banks.
 

Shadow banks often take on risks that traditional banks would either be unwilling to, or would be restricted from taking on as a result of tighter regulations.

The lax in regulations within the shadow banking system has meant that these institutions can provide credit to people or entities that would not otherwise receive such access.

Although shadow banks provide liquidity in a similar fashion to that of traditional banks, the method of offering loans through credit is fundamentally different.

Differences

One difference between the two systems is that with traditional banks, it is depositors that place their money into the bank. With shadow banks, it is investors that place their money into the bank.

The second big difference between them is the amount of regulatory oversight.

Traditional banks are regulated to protect depositors in the case of a bankruptcy. If a traditional bank were to experience bankruptcy, then depositors would receive their money back through depositors insurance (i.e. FDIC, CDIC)

This deposit insurance helps ensure bank runs are less likely because it provides a safety net for depositors, thereby guaranteeing against such an incident.

However, under a shadow banking system, there is no investment insurance provided by the government, thus these banks do not offer the same level of protection as traditional banks.

Another difference between the two systems is that the shadow banks often participate in areas that lack transparency and regulations such as dark pools.

Dark Pools
 

Dark pools are exchanges where shares are bought and sold in a private market. Unlike public stock markets such as the New York Stock Exchange (NYSE), dark pools are not made available to the public…..MOREHERE