Question

1. This question refers to systemic risk and the shadow banking system
   1. Discuss the sort of systemic risk that the shadow banking industry poses.
   2. What sort of regulation is in place to address systemic risk?
   3. Discuss the fragility of the shadow banking system and whether you think that shadow banks are as vulnerable to funds today as they were during the financial crisis of 2007-09

Answer 1

a. Shadow banks are financial institutions outside the traditional banking sphere that aren't governed by U.S. banking regulations.

The risk could include direct and indirect exposure to banks, insurance firms and retirement funds, decreased availability of finance for banks and non-financial corporate borrowers, and enhanced volatility of asset prices

b. Recognition of the prospective role of macroprudential policy in defining and addressing systemic risk and offering a consistent structure for prudential projects needed to balance financial stability with sustainable economic growth was one of the most important characteristics of the post-crisis retrospective. The sort of policies endorsed by financial managers can be categorized into two main classifications: structural policies that are in impact at all times, and time-varying policies that are designed to limit excessive loan build-up at moments of cycle exuberance. Systemic risk detection and mitigation lies at the core of efficient macroprudential policy making.

The addition of macroprudential instruments to the regulator toolkit could become critical in decreasing systemic imbalances with short-term interest rates in developed countries hovering around zero. While low inflation and high unemployment predict central banks to continue accommodating monetary policy, dangers arising from the prospective creation of asset bubbles in select asset classes are a increasing problem that could be resolved by macro-prudential regulation.

c. In a general sense, and as the FSB has expressed, the more resilient version of shadow banking is market-based finance. This is not to indicate that all shadow banking activity should be stopped— as stressed by the Fund and the FSB, shadow banking can serve helpful economic tasks, but in certain situations regulators need to ascertain whether there are characteristics that may be more likely to create financial stability hazards, and if so, operate through the policy consequences. On another measure, this time focusing exclusively on the U.S. Flow of Funds, one can see a broadly similar trend—assets intermediated through simple and insolvency-remote collective investment vehicles like bond mutual and exchange-traded funds have more than doubled since 2007, while the assets of broker-dealers, finance companies, asset backed securities issuers and money market funds (MMFs) have almost halved Importantly, interconnectedness has also reduced