The aim of this paper is to show how the shadow banking system actually works and what kind of setup and products these financial intermediaries use to avoid regulation. The focus is on the overall system which makes it possible for shadow banks to compete against traditional banks while avoiding the traditional banking regulation. This paper describes how capital-intensive companies and money market funds are important parts of the system, as it is these who are looking for risk-free investment opportunities, thus creating a demand as shadow banks can satisfy. The extraordinary growth of the shadow banks compared to the traditional banks has been supported by even harder regulations of the traditional banks. Securitisation is one of the main activities of the shadow banking system. It is used to transform illiquid assets such as collections of mortgages into Asset-backed securities. Major investment banks were, in the years up to the financial crisis, the biggest customers for the rating agencies. These ratings were needed because the securities were so complex that the investors could not exactly find out what kind of risks they took, when they bought the investments. The shadow banking system is analyzed by two models from economics of banking theory. These models show that in a setup with large investor wealth, the shadow banks will answer with maximum use of securitisation. The shadow banks use securitisation to create securities such as Collateralized Debt Obligations (CDO’s). These products can, to some extent, satisfy the investors demand for AAA-rated investments. The problem with the shadow banking system is that it makes a high degree of leverage and high grade of interdependence between the financial intermediaries.
|Educations||MSc in Business Administration and Management Science, (Graduate Programme) Final Thesis|
|Number of pages||79|