Into the shadows
A South African perspective on Shadow Banking
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The shadow of the traditional banking system has lengthened
in recent years as the golden sun of profit past is forced to the
horizon by the weight of greater regulatory burden.
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Indeed, we have seen the demise of traditional banking giants
such as Lehman Brothers in the wake of the financial crisis.
Subsequent regulatory reform has weighed heavily on the
profit margins of banking institutions across the globe. In the
United Kingdom, the five biggest banks (Barclays, RBS, HSBC,
Lloyds and Standard Chartered) reported a 40% reduction
in combined profit as a result of regulatory fines, redress of
customer provisions, and accounting consequences.
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Standard Bank Group’s new joint chief executive officer Sim
Tshabalala, was quoted by the Mail & Guardian in 2011 as saying
that “[w]e’ve never faced so much regulation in the history of global
banking”. Mr Tshabalala continued to argue that South African banks
have at least 150 pieces of non-banking legislation to contend with.
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It is in these stringent regulatory conditions that shadow banking
activities flourish. But what is shadow banking and why does it
flourish where formal banking regulation is at its strongest?
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Defining and quantifying the shadow banking sector
The United Kingdom Financial Stability Board (“FSB”) broadly defines
it as credit intermediation involving entities and activities outside
the regular banking system. Based on the activities of these “other
financial intermediaries”, the FSB argues that the sector has grown
from $26 trillion in 2002 to $62 trillion in 2007 before declining
sharply in 2008. It estimates the current value of the sector at
approximately $67 trillion.
But there are disparate definitions of the concept. For the purposes
of compiling its Shadow Banking Index, Deloitte includes only money
market mutual funds, asset backed commercial paper conduits, assetbacked securities, non-agency mortgage-backed securities, collateralised
debt obligations, repurchase agreements (“repos”), securities lending,
and agency mortgage backed securities in its definition.
Based on this definition, Deloitte found dramatic growth in the
United States shadow banking sector between 2004 (the base year
for the index) and 2008. Thereafter, the index dropped significantly
and has been stable ever since.
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Why ‘shadow banking’?
The term shadow banking arguably carries too negative a
connotation.
Essentially, it is a sector that brings lenders and borrowers together
in a less formal way than normal banking channels. As such they
avoid the suite of regulation that banks are subjected to as well as
the related costs. These transactions are therefore often more cost
effective even though they may carry greater risk.
The concept is therefore not new – in fact one could argue that
shadow banking established banking activities.
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