'Shadow banking' is an unfortunately pejorative term which has been applied, since the Great Financial Crisis, to market finance (as opposed to bank finance). It is defined, for regulatory purposes, as traditional banking activity conducted by non-banks. The regulatory concern is that 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 protection or official 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 and liquidity intermediation and the creation of leverage on a scale that could 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. Complexity is also seen as making the repo market opaque. Moreover, it is argued that, because of the lack of safety nets, shadow banks have to rely on securities financing transactions (SFT), including repo, and that collateral is pro-cyclical (amplifying credit growth in booms and accentuating credit shrinkage in busts --- see question 32).
However, repo is not intrinsically a shadow banking instrument, as it is not used exclusively by so-called shadow banks. Indeed, it is mainly 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.
Back to Frequently Asked Questions on Repo contents page
<<< Previous page Next page >>>