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35. Is repo a type of ‘shadow banking’?
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‘Shadow banking’ is an unfortunately pejorative term which has been applied, since the financial crisis, to ‘market finance’. It is defined, for regulatory purposes, as traditional banking activity conducted by non-banks. However, this bank-like activity falls partially or entirely outside the scope of prudential capital and liquidity regulation and beyond the safety nets provided by deposit insurance or lenders of last resort. Nevertheless, there are linkages and feedbacks into the regulated banking system. Moreover, credit intermediation in the shadow banking sector involves maturity intermediation and the creation of leverage on a scale that can pose systemic risk. And because the process often takes place in stages, along complex chains of transactions between separate entities, and lacks safety nets, it is seen as particularly susceptible to contagion risk, which may amplify systemic risk. Moreover, it is argued that, because of the lack of safety nets, shadow banks have to rely on securities financing transactions, including repo, and that collateral is pro-cyclical (amplifying credit growth in booms and accentuating credit shrinkage in busts --- see question 30).

However, repo is not intrinsically a shadow banking instrument, as it is not used exclusively by so-called shadow banks. Thus, it is widely employed by commercial banks and securities firms --- all of which are regulated entities --- and increasingly by regulated end-users such as pension funds and insurance companies. This is the predominant case in Europe (whereas money market mutual funds --- classic ‘shadow banks’ --- play a major role only in the US market). Repo is also the principal tool used by central banks in the implementation of monetary policy and when acting as lenders of last resort.

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