The troubling rise of shadow banking | Number Theory

What was once seen as a peripheral feature of the financial system has now become central to how modern capitalism allocates risk and capital

Over the past decade, global finance has moved outside traditional banks. This shift is often described as the rise of shadow banking, a loose term for credit and financial activity carried out by non-bank entities that perform bank-like functions but sit outside the core regulatory perimeter. What was once seen as a peripheral feature of the financial system has now become central to how modern capitalism allocates risk and capital. This expansion is unfolding at a time of buoyant markets, lighter oversight and incentive structures that prioritise short-term gains, raising uncomfortable questions about whether the financial system is once again building vulnerabilities in plain sight.

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  A financial system outside the banks

  By the end of 2024, global finance had quietly crossed a threshold. More than half of the world’s financial assets now sit outside the banking system. The Financial Stability Board estimates that the non-bank financial intermediation (NBFI) ecosystem held assets worth about $256.8 trillion, around 51% of global financial assets, and it is growing much faster than banks, expanding by about 9.4% in 2024 compared with 4.7% for the banking system. The term shadow banking is often used loosely to describe this wider non-bank universe, which includes insurers, pension funds, investment funds, finance companies and market intermediaries, even though a considerable part of it is not inherently risky. To identify what most people recognise as shadow banking in substance, regulators focus on what they call the “narrow measure” of NBFI, which captures non-bank activities that involve bank-like credit intermediation such as leverage, maturity transformation or reliance on short-term funding. By this definition, global shadow banking assets stood at $76.3 trillion in 2024, close to 30% of the wider NBFI sector, and that share has been rising steadily.
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  Why shadow banking keeps expanding

  The rise of shadow banking has been driven as much by policy choices as by market forces. In the years after the 2008 global financial crisis, regulators tightened capital, liquidity and leverage rules for banks, making traditional balance-sheet lending more expensive and, in some cases, less attractive. Credit demand, however, did not disappear. Instead, it shifted towards non-bank channels that could perform similar functions with fewer constraints. Data from the FSB show that growth within non-bank finance has been driven overwhelmingly by other investment funds, which account for the largest share of the increase in NBFI assets. In effect, balance-sheet intermediation has increasingly given way to market-based finance, where valuations and flows matter as much as loan books. This shift has been reinforced by financial innovation, from fund-based lending to securitisation structures that allow risk to be packaged and distributed outside banks.
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  Where the risks lie

  The risks posed by shadow banking stem less from its size than from its composition. A large majority of global shadow banking activity is concentrated in run-prone investment funds, classified by the Financial Stability Board as economic function 1 (EF1). These include money market funds and certain fixed-income and mixed funds that offer investors daily liquidity while holding assets that can be hard to sell quickly in stressed markets. This structural mismatch makes them especially susceptible to “run risk,” which means that they tend to amplify shocks rather than absorb them, according to the FSB. Unlike banks, such entities do not benefit from deposit insurance or assured access to central bank liquidity. This vulnerability is compounded by incentive structures that echo those seen before the 2008 financial crisis. As former Wall Street executive Ken Miller wrote in a recent essay for The Economist, “Today’s private-credit industry has recreated the incentive structure that fuelled the subprime-mortgage boom—only on steroids and with less oversight.”
• Why banks are still exposed

  The growth of shadow banking has not insulated the banking system from risk. Across jurisdictions, banks’ funding of non-bank financial intermediaries ranges from negligible levels to nearly 40% of NBFI assets, while banks’ direct exposures to non-banks reach up to 11.3% of bank assets in some systems, according to the FSB. These links are reinforced through wholesale funding and repo markets, where non-banks rely heavily on short-term finance and money market funds alone supply almost $3 trillion in net repo liquidity. Such connections mean that stress originating in shadow banking can still flow back into the regulated core. Beyond these linkages lies private credit, the fastest-growing but least visible segment of non-bank finance. The FSB’s underlying data capture only about $0.5 trillion of private credit assets, far below market estimates of $1.5 trillion to $2 trillion. While private credit funds are not typically prone to runs, their opacity, borrower-level leverage and growing ties to banks make them the next major blind spot in global finance.