In an ominous warning to G20 heads of state before the global summit, University of New South Wales’ director of the Institution of Global Finance, Professor Fariborz Moshirian, has warned of the growing risk to the world economy of shadow banks.

Professor Fariborz Moshirian. Photo:

Professor Fariborz Moshirian. Photo:

Shadow banks are any person or institution with the capacity to legally lend money to another party. These might include investment, mutual, or hedge funds. The problem being that as they are not banks, they are not regulated or governed by banking laws.

In the wake of the Global Financial Crisis banks have seen their governance enshrined in very carefully worded laws. They have tightened their criteria for lending, and taken a much greater role in the protection of investors and lenders alike. Shadow banks are not required to meet such standards.

For instance shadow banks don’t take ‘deposits’. They lend against their own, rather than the borrower’s, capital.

While banks must adhere to a strict lending versus capital schedule shadow banks can decide their own ratio. They can leverage themselves to the sky if they wish (exactly what Lehmann Brothers did to start the avalanche precipitating the GFC).

Professor Moshirian estimates there is $75 trillion in global assets currently controlled by shadow banks. “The key issue,” he told, “around shadow banking is due to the fact that we are putting more pressure on actual banks to be more prudent in their lending. Unwittingly, that has led to the expansion of the non-banking sector.”

This is because investors, looking for higher interest returns, will be tempted to place their money with more highly leveraged (and thus more highly performing) shadow banks than with the more tightly controlled (and therefore lower performing) regular banks.

Professor Moshirian said that with such a vast amount of assets being held by shadow banks the global economy is already vulnerable. “If shadow banks withdraw their funds from the market, it could create more uncertainty to the global economy.”

To give you some idea of what $75 trillion means to the world economy – it is roughly the GDP of the entire world for one year.

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