Shadow Banking

These firms do bank-like things, such as lending, taking short-term funding and turning it into longer-term assets, but they are not licensed deposit takers. Examples include money market funds, some investment funds, finance companies, securitisation vehicles and certain lenders that rely on repurchase agreements. Because they fund long assets with short money and have no deposit insurance or central bank backstop, a loss of confidence can force sudden asset sales, much like a bank run. They are also linked to banks through lending lines, ownership and shared markets, so stress passes into the formal system. Regulators now often use the milder term non-bank financial intermediation, since much of it is useful and not hidden. The FSB tracks its size every year. Bank supervisors cannot see this build-up in their own data, which is why regulators track it separately.

A finance company funds long-term loans by issuing short-dated paper that investors roll over every month. When investors lose confidence after a few defaults, they stop rolling it over. The company must sell loans quickly at a discount, prices in that market fall, and the banks that lent to it face losses despite their own strong ratios.