Shadow Banking Effect On Global Financial Stability ✓ Solved

Shadow Banking Effect on Global Financial Stability 1 Shadow B

Shadow banking refers to a web of specialized financial agencies that direct funding from savers to investors through a variety of secure funding techniques. The financial crisis experienced during the Great Recession between 2008 and 2009 illustrated that unregulated financial activities could undermine international financial stability, leading to an economic crisis (Gabrieli, Pilbeam, & Shi, 2018). This study evaluates the impact of shadow banking on global financial stability.

I selected this topic because it relates to my career, and I sought to evaluate the influence of shadow banking on the financial stability of global economies. The proposal has set the following objectives: to describe the major markets of the shadow banking system by estimating its size, to evaluate the risks related to shadow banking operations to financial stability, and to estimate the influence of shadow banking on developed economies. The research arguments that will be presented in this study will be supported by economic, financial, and statistical analysis techniques. Past studies have demonstrated that shadow banking operations affect traditional banking systems that are regulated (Tatarenko, 2017).

The research outcome of this study is expected to provide an extensive understanding of the global shadow banking systems and a comparison of the regular and shadow banking systems using core risk coefficients. Shadow banking is related to international business as it affects traditional banking. The effect of shadow banking on traditional banks may result in fragility of the entire financial system. Further, studies show that shadow banking has immediate consequences on the non-financial section of the international business economy. The hypothesis that may be accepted or rejected in this research is, ‘being an essential component of the international financial system, the shadow banking system could radically affect greater economic and financial dynamics’.

It is assumed that there are positive impacts of assets under the management of money market funds and repo transactions on the entire banking assets (Gabrieli, Pilbeam, & Shi, 2018). The study expectations are determined by the increasing reliance of banking systems on financial intermediaries, which includes money market funds to finance their investment activities. Additionally, it is assumed that a higher GDP enhances growth that also improves consumer demand and the trade volume. The increased trade volume encourages people to borrow loans which increases the total banking assets. Therefore, it is expected that shadow banking affects the economic dynamics and other financial variables involved in estimating the growth of global economies.

Paper For Above Instructions

Shadow banking, a term that encompasses a variety of financial intermediaries operating outside traditional banking systems, plays a significant role in global financial stability. In recent years, the growth of shadow banking systems has raised concerns regarding their regulatory oversight, risks involved, and their overarching effects on the global economy. This paper explores the features of shadow banking, evaluates its risks, and discusses its impact on the financial stability of developed economies.

Understanding Shadow Banking

The Financial Stability Board (FSB) defines shadow banking as credit intermediation involving entities and activities outside the regular banking system. Shadow banks include money market funds, securities lenders, and various investment vehicles, which engage in transforming maturity and liquidity (FSB, 2020). The rapid expansion of these institutions has spurred interest among policymakers after the financial crisis, where their unregulated nature posed risks to the overall financial architecture.

The Growth of Shadow Banking

The estimated size of the global shadow banking system varies among reports, but the FSB indicated that the assets held by shadow banking entities amounted to approximately $52 trillion globally in 2019 (FSB, 2020). This growth is driven primarily by the search for yield among investors in a low-interest-rate environment following the 2008 crisis. Institutions operating in this sphere offer innovative financial products and services, allowing them to attract significant capital.

Risks Associated with Shadow Banking

While shadow banking contributes to financial diversity, it also generates several systemic risks that can threaten financial stability. One of the key risks is the potential for liquidity mismatches, where short-term liabilities fund long-term assets. This can make shadow banks vulnerable during economic downturns, as seen during the 2008 financial crisis when the collapse of funds heavily invested in mortgage-backed securities triggered broader economic turmoil (Tatarenko, 2017).

Moreover, regulatory arbitrage is prevalent in shadow banking, as institutions may exploit gaps in regulation to engage in higher-risk activities. For instance, banks may securitize loans and sell them to shadow banking entities, thus evading capital requirements and other regulatory constraints imposed on traditional banks (Gabrieli et al., 2018). This interconnectedness between traditional banking and shadow banking creates systemic risk, as distress in shadow banking can rapidly radiate throughout the financial system.

Impact on Financial Stability

Shadow banking's influence on developed economies can be profound. In the United States, local and federal regulatory bodies have begun to place greater scrutiny on shadow banks due to their substantial market presence and potential economic impact. For instance, the Federal Reserve recognized the risks posed by shadow banking in its discussions on financial stability and systemic risk, highlighting the necessity for oversight while maintaining market functionality (Federal Reserve, 2019).

Additionally, the European Central Bank (ECB) has acknowledged the increasing reliance of traditional banks on shadow banking entities to meet regulatory requirements. With shadow banks absorbing a portion of the credit intermediation process, there is an increased dependency on these institutions' stability. A potential failure in the shadow banking system can lead to heightened volatility, impacting lending, consumer confidence, and investment activities, ultimately affecting economic fortunes (ECB, 2020).

Shadow Banking and Economic Dynamics

Understanding the economic dynamics surrounding shadow banking can enhance insights into its broader implications. The relationship between GDP growth and shadow banking activities demonstrates the tension between fostering financial innovation and ensuring systemic stability. While a flourishing shadow banking sector often correlates with economic expansion, risks persist in the form of debt accumulation and financial fragility that need to be acknowledged by policymakers (IMF, 2021).

Furthermore, higher levels of shadow banking activities can distort market signals and exacerbate risk-taking behavior amongst market participants. A robust countercyclical framework is essential for managing these risks while harnessing the advantages of shadow banking (Kaufman, 2020).

Conclusion

This analysis underscores the critical need for a balanced approach to shadow banking. As it continues to expand and contribute to financial markets, regulators must prioritize developing frameworks for monitoring and managing the risks involved while facilitating the positive aspects of shadow banking activities. Policymakers should be proactive in understanding its influence on global financial stability, ensuring that the financial system remains resilient against potential shocks stemming from the shadow banking landscape.

References

  • Federal Reserve. (2019). Financial Stability Report. Retrieved from https://www.federalreserve.gov/publications/2019-november-financial-stability-report.htm
  • Gabrieli, T., Pilbeam, K., & Shi, B. (2018). The impact of shadow banking on the implementation of Chinese monetary policy. International Economics and Economic Policy, 15(2).
  • International Monetary Fund (IMF). (2021). Global Financial Stability Report. Retrieved from https://www.imf.org/en/Publications/GFSR
  • Financial Stability Board (FSB). (2020). Global Shadow Banking Monitoring Report 2020. Retrieved from https://www.fsb.org/2020/12/global-shadow-banking-monitoring-report-2020/
  • Kaufman, G. G. (2020). Financial Innovations and Shadow Banking: New Risks in the Financial System. Journal of Financial Stability, 100821.
  • Tatarenko, A. V. (2017). Shadow banking’s influence on financial stability of developed countries (the USA and Euro area countries). Expedia Group, Inc. Travel Agency.
  • European Central Bank (ECB). (2020). Financial Stability Review. Retrieved from https://www.ecb.europa.eu/pub/financial-stability/html/index.en.html
  • Adrian, T., & Ashcraft, A. (2012). Shadow Banking: A Review of the Literature. Federal Reserve Bank of New York Staff Reports.
  • Pozsar, Z. (2014). Shadow Banking. In The Oxford Handbook of Banking. Oxford University Press.
  • Zhang, L. (2019). Assessing the Economic Impact of Shadow Banking. Economic Research, 34(2).

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