Shadow banking activities operate outside traditional regulatory frameworks from "summary" of Financial Markets and Institutions, Global Edition by Frederic S. Mishkin,Stanley G. Eakins
Shadow banking activities refer to a range of financial activities conducted by non-bank financial institutions, such as hedge funds, money market funds, and investment banks, that operate outside the traditional regulatory frameworks that govern banks. These activities often involve the creation and trading of complex financial products, such as mortgage-backed securities and collateralized debt obligations, that can have significant implications for the stability of the financial system. One key characteristic of shadow banking activities is their reliance on short-term funding sources, such as repurchase agreements and commercial paper, to finance their operations. These funding sources can be volatile, as they can be quickly withdrawn in times of financial stress, leading to liquidity problems for shadow banks that can spill over into the broader financial system. Another key feature of shadow banking activities is their use of off-balance sheet structures to shift risk away from traditional banks and onto investors. This can create opacity in the financial system, as the true extent of risk exposure may not be immediately apparent to regulators or investors. This lack of transparency can make it difficult to assess and manage systemic risks that may arise from shadow banking activities. The rapid growth of shadow banking activities in recent years has raised concerns among policymakers and regulators about the potential for these activities to destabilize the financial system. While shadow banking can provide valuable services, such as increasing liquidity and efficiency in financial markets, it also poses risks that need to be carefully monitored and managed. As such, efforts have been made to bring shadow banking activities more fully within the regulatory framework to enhance transparency and reduce systemic risk.
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