The global economy remains frail and fragile, and economic growth rates remain at moderate levels, insufficient to ensure a sustainable recovery following the 2007/2008 global recession. The crisis has, once again, proven how intertwined and tightly weaved the world economy is. It swept like veldt fire through advanced or economically developed countries to less developed world. The results were negative, but their intensity they varied from country to country. The crisis was, however, just one the few that have torn through world economy.
As a matter of fact, it has been noted that by Du Toit (2009:2) that the recent macroeconomic history of emerging market economies is coloured with economic crises of all kinds, ranging from debt-crises, through hyperinflationary periods to currency crises to name but a few. Over the years, the finger of blame as to who caused which crises has been shifting from one agent of the economy to the other, all through the world. However, it may be more concise and academically balanced to say all the economic agents, including the government, the private sector, those in the financial sector, just to mention a few, have failed (Du Plessis, 2011:3).
Over the years, the world economy has witnessed the evolution of international financial system (IFS), shadow banking being one of the highlights. Some economists argue that these transitions have made the world economy more vulnerable to financial downswings, some have chosen to argue otherwise opining that these transitions have been beneficial to world economic development. In any case, it is clear that the financial crisis has given birth to, and resurrected, lively debates and interest in the IFS and its reform. Recently, the focus of the G20 has been coming up with a reform in an effort “to build a more stable and resilient international monetary system” (Camdessus et al, 2011:1). However, shadow banking, which remains highly unregulated and unsupervised, has not been given special focus as far as reforms are concerned (FSB, 2012:2), despite the fact that it contributed to the 2007/8 financial crisis in one way or the other. This paper assesses the risks and/or concerns of shadow banking as a part of the IFS. It is divided into headings and subheadings as follows:
WHAT IS SHADOW BANKING?
Over the years, different definitions of shadow banking have emerged. For the purposes of this paper, a definition used in the Financial Stability Board (FSB) reports will be adopted, wherein shadow banking is defined as “the system of credit intermediation that involves entities and activities outside the regular banking system” (FSB 2011:1 and FSB, 2012:2). These entities perform the important roles of credit risk transfer, liquidity and maturity transformation (Pozsar et al, 2010:2). Other important functions performed by these entities include securities lending and handling of repurchase transactions or agreements (repos) (FSB 2011:2). Shadow banking is significantly important in the South African market as it an engine for risk diversification, and it derives its strength from the fact that South Africa has adequately capitalised banks (BusinessReport, 2012). Shadow banks have, over the past decade, succeeded in performing an important role of converting long-term assets which appear to be risky into short-term liability. This in turn, contributed immensely to appreciation of the asset prices prior to the 2007/8 financial crisis (Pozsar et al, 2012:1). It is for this reason that economist have, recently, argued that the crisis exposed the frangibility of shadow banking system as a form of intermediation in the IFS.