A levered-up financial intermediary that doesn’t have access to any form of liquidity protection. Commercial banks, by nature, have access to two key forms of liquidity protection: (1) deposit insurance and (2) access to the central bank’s discount window as lender-of-last-resort support. Shadow banks carry out maturity, credit, and liquidity transformation without access to central bank liquidity or public sector guarantees. Being mainly unregulated, shadow banks are, nonetheless, involved in the creation of credit, and unregulated activities of regulated institutions (unlisted derivatives, credit default swaps, etc). Originally, shadow banks escaped regulation because of their non-depository nature (i.e., contrary to conventional banks, they didn’t take deposits).
The key shadow banking structures include investment banks, hedge funds, collateralized debt obligations (CDOs), finance companies, asset-backed commercial paper (ABCP) conduits, and money market funds. These entities played a major role in the financial crisis that broke out in 2007 by providing more credit than what conventional banks provided.
Shadow banks are a financial innovation of the 1980s.
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