Sometimes the non-banking financial institutions provide services that are outside the rules and regulations that are imposed by the concerned government. These institutions provide similar activities like traditional banking but do not have to follow regular banking regulations. Here is FinanceShed with the complete guide on Shadow Banking.
What is Shadow Banking?
Shadow Banking System means the banking activities carried on by the financial institutions which are not authorized to do so and all the activities carried on by such financial institutions which are either unregulated of unauthorized are known as the shadow banking activities.
The shadow banking doesn’t need to comply with any of the regulations primarily as they don’t accept the deposits as like as the traditional banks do. So all the rules which are applicable to the traditional banks don’t apply to the shadow banking institutions due to their lack of capacity of accepting deposits.
There are Certain Threats to the Use of Shadow Banking Activities
Safety for the Investors
When the lenders of the regulated banks give money to them than it will be insured under the policy so if the regulated institutions lose the money there will be less loss to the investors as they can receive the insurance amount but in the unregulated sector there will be no Universal Insurance in most of the cases, so if the unregulated sector lose money their investors will also lose it.
There is no liquidity in the unregulated sector as there will be not much short term funds with the shadow banks and that is why it is one of the drawbacks of shadow banking. The regulated sectors invest in both the long term and short term so if there is the situation of the crisis it will not be hard for them to convert their investments into the cash, whereas the unregulated sector have the lending in long terms more to gain more profit so in time of crisis they have to borrow money for short term.
At the time of recession it will be difficult for the shadow banking to survive as the banks will be able to survive after the recession as they have the back of government as well as The Insurance Companies so if the recession period arrives then the unregulated institutions will lead to huge problems as it will be difficult for them to survive.
As there are the drawbacks of the shadow banking there are some of the positive aspects also which are useful for the unregulated sector to survive.
- As the unregulated sector helps the economy in the same way as the regulated sector does the only difference is that they are not bound by the banking regulations so if the shadow banking is taken in a positive way it will lead to helping of the banking sector in the economy.
- Sometimes when the regulated sector fails to provide some service or any of the opportunity to develop economically than at that time it will be the shadow banking sector which will be helpful to the economic benefits.
These were some aspects of shadow banking in the economy as well as The Development of Lending Business in the unregulated sectors. There are arguments regarding the regulations by the government for these sectors as there are opinions about regulating all entities that collect deposits and make loans.