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Shadow Banking and Insurance
Daniel Schwarcz University of Minnesota Law School
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A broad definition of Shadow Banking
(1) Potentially short-term liabilities, (2) Backing potentially illiquid assets, (3) Where traditional restrictions and back-stops of bank regulation are not present. Important Note: Shadow banking is only one specific way in which non-bank financial firms/markets can pose systemic risks.
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(1) Potentially Short-term Liabilities
(a) Insurance Products with High Liquidity GICS, Synthetic GICS, Deferred Annuities, Funding Agreements, Retained Asset Accounts (b) Short-term Letters of Credit used to support captive reinsurance transactions (“shadow insurance”) (c) Securities Lending operations
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(2) Backing Potentially Illiquid Assets
(a) Insurer assets often are illiquid by design, on assumption that liabilities will be long-term Corporate bonds; securitized bonds; real estate (b) Insurers exhibit substantial herding in investment strategies, which can decrease liquidity in periods of stress
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(3) Where traditional restrictions and back-stops of bank regulation are not present.
(a) State Guarantee funds are not pre-funded, contain substantial restrictions, and are premised on lack of systemic disruption in industry (b) State insurance regulation is focused predominantly on entity-level regulation by individual states rather than consolidated regulation of larger enterprises.
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For more from me on these issues
Regulating Systemic Risk in Insurance, 81 University of Chicago Law Review 1569 (2014) (with Steven Schwarcz) A Critical Take on Group Regulation of Insurers in the United States, 5 University of California Irvine Law Review 537 (2015) The Risks of Shadow Insurance, 50 Georgia Law Review 163 (2015)
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