Shadow banking may help drive the day-to-day financial system, but it is a concept looking for a hard-and-fast definition.
Despite coming under intense scrutiny following the financial crisis, there have been disparate characterizations of what the shadow banking sector truly entails — with size estimates ranging from $10 to $60 trillion. At the same time, major regulatory efforts have either been enacted or are in the works to help reduce the size of this important sector, with no agreed-upon way to measure their effectiveness.
The purpose of the Deloitte Shadow Banking Index is to define and quantify the sector over time, including its components. This ongoing effort is designed to more closely measure size, importance, effect of market, and impact of regulatory actions, as well as a way to assess the potential impact of shadow banking on regulated markets.
What is shadow banking really? We started by including a multitude of nonbanking entities and activities and then applied specific criteria. For example, we posit that money market mutual funds (MMMFs) are part of shadow banking as they possess the “money-like” attributes of bank deposits. But they do not have bank-like insurance, nor can they access a central bank for liquidity support.
After determining the components, we created the Deloitte Shadow Banking Index, beginning with data from 2004 set at a base value of 100. We chose this period due to data availability; while we elected to focus only on the U.S. in this initial iteration of the Index, we may include global information in the future.
What the Index has found – unsurprisingly – is that there was a dramatic growth of the sector between late 2004 and late 2008, which even eclipsed the size of the traditional banking sector. Since then, there has been an abrupt decline – both in absolute terms and relative to the size of the traditional banking sector – amid a backdrop of economic crisis and volatility, increased regulation, and significant changes in the regular banking system. By our measure, the sector was some 25 percent smaller at the end of 2011 than at the end of 2004, totaling $9.53 trillion.
The shadow banking sector in the U.S. will likely remain suppressed in the near-term, though it is unlikely that it will cease to exist; repurchase agreements (repos) and securities lending, to name two components, are vital to the functioning of the modern financial system and will likely bounce back eventually.
Does this mean that the significance of the shadow banking system is overrated? No. The growth of shadow banking was fueled historically by financial innovation. A new activity not previously created could be categorized as shadow banking and could creep back into the system quickly. That new innovation might be but a distant notion at best in someone’s mind today, but could pose a systemic risk concern in the future.
The Deloitte Shadow Banking Index shows dramatic changes in shadow banking over a few years. From a base of 100 in 2004, it reached a peak of 162.5 in Q1 2008, with the sector’s assets growing to over $20 trillion. Since then, the Index has dropped steadily, primarily due to regulatory action and market conditions, reaching a value of 75 as of Q4 2011. Assets were then $9.53 trillion, over 50 percent below peak.
Shadow banking is an integral part of the financial system, rivaling the size of regular banking. We expect the shadow banking market and definition to continue to evolve. Perhaps the biggest change on the horizon is what the Financial Stability Board (FSB) will do concerning shadow banking globally when recommendations from G20 leaders are released by the end of this year. We will continue to track developments and consider what, if any, modifications should be made based on the FSB’s moves.
We are committed to updating the components and value of the Deloitte Shadow Banking Index in the future as a way to help frame the market size, assess the impact on the economy, and offer insight regarding the regulatory debate about this important set of activities. The Index is designed to assess the answers to questions such as:
- What will shadow banking look like in a few years?
- How might regulatory developments affect shadow banking?
- Will new shadow banking activities emerge as a result of market change or regulatory action?
The Deloitte Shadow Banking Index is designed to facilitate greater understanding of this subject, and allow both market participants and regulators to assess the impact of their programs.