Question

Since 1970s, shadow banking has developed in various degree around the world. Comment on ANY THREE potential hazards of shadow banking. It is argued that banks tend to violate their management principles in shadow banking. Discuss bank management principles.

Answer 1

Shadow banking refers to non-bank financial intermediaries that provide funds to traditional banks and without the funds from such institutions traditional  banks will not be able to  lend money and thus there will be less growth in the economy.Three risks that shadow banking gives rise to are firstly they are not structured to deal with the periods when there is  low liquidity as well as huge withdrawals. Secondly they do not have the experience to deal with the periods when credit conditions are weakening. Thirdly,they do not have diversification of earnings which would hurt shadow banking.

Banks manage their assets and liabilities so that they can earn profits.Banks make sure that there are enough cash to pay depositors in case there are huge capital outflows. So the first principle is liquidity management by the bank.Second principle is asset management when banks should acquire assets that have low rate of default . Banks aslo minimize risk by diversifying asset holdings. Thirdly it is liability management ie to get funds at low cost .Finally it is capital adequacy management when the manager has to take decision regarding the amount of capital to be maintained by the bank and then acquire the capital.