Financial intermediation outside the regulated banking system with minimal oversight
Shadow banking refers to financial intermediation conducted outside the regulated banking system — including hedge funds, money market funds, structured investment vehicles, and other entities that perform bank-like functions (taking in money and making loans or investments) without being subject to the regulations, capital requirements, or oversight that apply to traditional banks.
The shadow banking system grew dramatically in the decades before the 2008 crisis, reaching an estimated $60 trillion globally by 2010. These entities operated with higher leverage, less transparency, and no access to the Federal Reserve's lender-of-last-resort facilities. When the crisis hit, the interconnections between shadow banks and the regulated banking system transmitted losses throughout the entire financial system.
The shadow banking system represents a structural evasion of financial regulation — the financial equivalent of the intelligence community's black budget. By moving activities outside the regulatory perimeter, financial institutions can take risks that regulated entities cannot, using complexity and opacity to obscure what they are doing from regulators and the public. Despite post-crisis reforms, the Financial Stability Board estimates that the shadow banking sector continues to grow, now exceeding $60 trillion in assets globally.
