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Jackie Zimmermann/MEDILL

The Federal Reserve Bank of Chicago's 16th annual International Banking Conference focuses on the widespread implications of the growing shadow banking industry.

Possible cause of financial crisis still hiding in the shadows

by Jackie Zimmermann
Nov 7, 2013

Five years after the worst U.S. recession since the Great Depression, a possible culprit for the country’s financial woes still lurks in the shadows.

Shadow banks, financial intermediaries that work outside the confines of the traditional banking system, remain a point of concern for the industry, specifically due to their lack of regulation and oversight.

The Federal Reserve Bank of Chicago, in collaboration with the International Monetary Fund, brought the issue to the forefront during its 16th annual International Banking Conference, “Shadow Banking Within and Across National Borders,” Nov. 7-8.

Over the past 16 years, the conference has addressed the most pressing topics of the day, and “this year I think we’re spot on,” said Doug Evanoff vice president and senior research advisor for banking issues at the Federal Reserve Bank of Chicago, who moderated the first session of the event. “Shadow banking, a lot of people argue, was at the heart of the most recent financial crisis.”

Many of the conference participants have been involved in research aimed at understanding and regulating shadow banks globally.

“We can look backward easily for guidance,” said Nicola Cetorelli, assistant vice president in the financial intermediation function at the Federal Reserve Bank of New York. “But at the end of the day it’s also important to take a practical approach on how to tackle potential issues that might be on the plate and that the regulators have to address, especially facing the challenges of a global undertaking of the problem,” he continued.

Growing activity in international markets is a concern for experts, as the definition of shadow banking differs from culture to culture, making international regulation difficult. According to the Financial Security Board, the shadow banking industry amounts to $65 trillion to $70 trillion globally. At the end of 2011, the majority of the industry, 35 percent, was in the U.S., down from 44 percent in 2005.

A member of the FSB’s international working group on shadow banking, Cetorelli said the organization is working to define the scope and size of the industry as well as implement a global monitoring system and prepare regulatory proposals to address potential issues and weaknesses.

Shadow banks, which can include hedge funds, money market funds and structured investment vehicles, such as mortgage-backed securities, use derivatives to reduce their risk. However, because they lack direct access to central banks, they also operate with less regulation.