Shadow Banking

Traditional Banking – Everything on One Balance Sheet, Under One Roof Create/issue very short-term liabilities and create/but long term assets

Term “shadow banking” has been attributed to economist and money manager Paul McCulley Describes a large segment of financial intermediation that are outside the balance sheets of regulated commercial banks and other depository institutions. Conduct functions of banking “without access to central bank liquidity (Fed discount window) or public sector credit guarantees (FDIC)”.

2. Warehouse Bank 2. 3. 4. 5. 1. Loan Originator: commercial bank, finance company, mortgage bank, … mortgage, auto, credit card loans, .. 2. Warehouse Bank 2. 3. 4. 5.

Shadow Banking System CP, ABCP, Repo Originator: Originates a loan: auto, student, mortgage Commercial Bank Mortgage Company Finance Company such as Ford motor Credit Aggregator: Could be: the Originator An investment bank A large Commercial Bank They form pools and securitize the loans SPV Securitized ABCP Loans or REPO MMMF Loan doc. sell loans $$$ Shares $$$ Repo Investors: Any entity that has large amounts of cash they want to park for short period of time $$$ $$$ $$$ Take long-term assets and transform into very short-term liabilities.

Balance Sheets of Securities Firms and Investment Banks Note that large amounts of receivables represents trading activity Receivables represent trading activity, about 30% of assets. Long position (investments), about 24% of assets Purchase side of Repo, 34%. Lending short-term on the repo market. 8

45% of source of financing is short-term repo. Equity is low at 4.46%. Note that large amounts of receivables represents trading activity 45% of source of financing is short-term repo. Equity is low at 4.46%. 9