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A Call To Bring Banking Out of the Shadows

230420 Shadow Banks Blog

She also noted the risks of ‘the ongoing shift of traditional bank activities into shadow banks.’

Federal Reserve Board Governor Michelle Bowman is making the case for more banks, saying the process for startup banks to receive charters should be easier and more transparent.

“We need a viable pipeline for the creation of new banks in the United States,” Bowman said at the Wharton Financial Regulation Conference in Philadelphia. “There are troubling indications that we are falling short on this front.”

Bowman emphasized the need for more competition in an environment where the number of U.S. banks dropped from roughly 9,300 to 4,700 between 2002 and 2022, and pointed to the U.K.’s New Bank Start-up Unit as a potential model to emulate.

She also noted the risks of “the ongoing shift of traditional bank activities into shadow banks.”

According to the Financial Stability Board, nearly half of financial assets globally are held outside banks, in entities including pension funds and hedge funds. This non-bank sector has expanded rapidly since 2008’s global financial crisis, at an average clip of 7% a year, according to CNN.

In her speech, Bowman noted the dangers of shadow banks engaging in credit intermediation without the level of transparency and regulatory oversight found at a bank. When a shadow bank goes south, it can have knock-on effects to traditional banks due to links—perceived and real—between the two industries. An infamous example would be the failure of Archegos Capital Management in 2021, which saw banks lose some $10 billion.

Shadow banks account for 14% of global financial assets, CNN says, and often attract riskier assets and deals that traditional banks may not want to touch.

Despite indications that “tighter funding conditions and weaker macroeconomic conditions will likely slow down global shadow banking activity,” S&P Global says in a recent report that the potential for “contagion risk—via perceived proximity or reputational risk—should not be underestimated.”