What is Shadow Banking?-VRK100-05Oct2011

What is Shadow Banking?

Traditional banks seek deposits from savers and lend money to borrowers. Deposits in traditional banks up to a certain limit are protected by the government (like deposit insurance provided by DICGC in India). In the US, Federal Deposit Insurance Insurance Corporation or FDIC provides deposit insurance of up to USD 250,000 per depositor, per insured bank. Traditional banks are regulated and they get funding from central banks if a need arises.

On the other hand, shadow banks are financial intermediaries who take a lot of risk and are not regulated. Shadow banking system includes investment banks, hedge funds, structured investments, real estate investment trusts, money market mutual funds, collateralized debit obligations (CDOs) and others.

Shadow banks get their funding mainly from reverse repo and asset-backed commercial paper. Deposit insurance and central bank funding are not available to them.

Shadow banking system played a major role before the global financial crisis of 2007/2008. Due to the collapse of a few shadow banks, like, Bear Stearns and Lehman Brothers in 2008, shadow banking system suffered a major blow.