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Shadow banking: credit outside the banking system
· Concept
Fact, law or dataA rule, statute, definition or measured number.
Shadow banking is bank-like lending and borrowing done by firms that are not banks: money funds, repo dealers, securitization vehicles and private credit funds.
See it on the Money & Finance map →How it works
Like banks, these firms borrow short and lend long. A money market fund promises shares worth $1 on demand while holding short-term IOUs; a dealer funds bonds with overnight loans in the repo market; before 2008, special vehicles funded mortgage bonds with commercial paper. None had deposit insurance or, normally, Fed loans, so in 2008 their lenders ran. Regulators now call it nonbank financial intermediation; by Financial Stability Board estimates it holds about half of global financial assets.
Why it matters
It was the epicenter of the 2008 run, and risk migrates there whenever bank rules tighten. Debt funds, CMBS and mortgage REITs, all nonbank lenders, are major sources of commercial real estate loans.
Think of it like
Like financing a 10-year hold with 30-day loans rolled every month: it works until lenders stop rolling.
Facts, rules and data
Paul McCulley of PIMCO coined the term in 2007. A 2010 New York Fed staff report mapped the system; the Financial Stability Board publishes annual global monitoring reports.
Debates and risks
How much risk now sits in private credit, hedge funds and money funds, and whether the Fed should backstop them in a panic, is debated.
Inside this (2)
Connections (4)
▸How banks create money: lending and fractional reserves is mimicked outside banks by Shadow banking: credit outside the banking systemMainstream view
The connection
Banks fund long loans with deposits payable on demand. Shadow banks copy the trick: money funds offer $1 shares on demand while holding short-term paper, and dealers fund bonds with overnight repo. Without deposit insurance or routine Fed loans, they are exposed to runs the way banks were before 1934.
When and why
Grew from the 1970s with money funds and securitization; by 2007 US shadow-bank liabilities, roughly $20 trillion, exceeded traditional banks', per a 2010 New York Fed study.
How solid is the link?
Zoltan Pozsar and colleagues mapped the system for the New York Fed (2010); Gary Gorton and Andrew Metrick documented the 2007–08 'run on repo'.
Debates and risks
Whether shadow banks should get bank-style rules, a Fed backstop, or neither is unresolved; the 2008 and 2020 rescues of money funds widened the safety net anyway.
▸Shadow banking: credit outside the banking system suffered a run in The 2008 global financial crisisFact, law or data
The connection
Investment banks, mortgage vehicles and money funds financed long-term mortgage assets with short-term borrowing such as repo and commercial paper, without deposit insurance. When collateral values fell, lenders demanded more margin or stopped lending: a run without lines at the door. Bear Stearns and Lehman lost funding within days.
When and why
August 2007, when asset-backed commercial paper froze, through autumn 2008, centered on New York and London money markets.
How we know
Gary Gorton's research documented the 'run on repo'; FCIC and Fed data show commercial paper and repo shrinking sharply.
Debates and risks
Whether today's nonbank lenders, private credit funds and money funds could suffer a similar run, and who would backstop them, is debated.
▸Shadow banking: credit outside the banking system includes Private credit fundsFact, law or data
The connection
Private credit funds make loans banks used to make, without taking deposits. Unlike money funds or repo, they lock investors in for years, so classic runs are less likely. But they borrow from banks themselves, and bank lending to nonbank lenders has grown fast, tying the two systems together.
When and why
Grew after 2008 as Basel III and 2013 US leveraged-lending guidance pushed banks back; the IMF estimated about $2 trillion globally in 2023.
How we know
The IMF's April 2024 Global Financial Stability Report and Fed Financial Stability Reports classify it as nonbank lending and flag banks' rising loans to it.
Debates and risks
Whether it is safer than bank lending, thanks to locked-up capital, or a hidden risk because of opaque valuations and layered leverage, is debated.
▸Shadow banking: credit outside the banking system includes the money funds in Cash and money market fundsFact, law or data
The connection
Money market funds behave like bank deposits, promising $1 shares on demand, but invest in short-term IOUs without deposit insurance, which makes them a core shadow bank. When Lehman failed in September 2008, the Reserve Primary Fund fell below $1, sparking a run that froze corporate borrowing until the Treasury guaranteed money funds.
When and why
September 16–19, 2008, in New York and Washington; runs on prime funds struck again in March 2020, when the Fed opened an emergency lending facility for them.
How we know
SEC and Financial Stability Board reports classify money funds as nonbank intermediation, and SEC reforms in 2010, 2014 and 2023 targeted their run risk.
Debates and risks
Whether the 2023 reforms, including liquidity fees and larger cash buffers, end run risk, or whether money funds still rely on an implicit government backstop.