The Lure of, and Luring Shadow Banking

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Originally posted on:

The post-2008 rise of shadow banking continues to generate a dustup between those who view its nebulous activity as a bulwark against both illiquidity and inefficiencies in the distribution of capital, versus those who hold it as a perennial threat to global stability. The most recent Economist includes a special report on shadow banking, in which declamations of the system’s potential to vitiate regulated, on-balance sheet activity is cast aside in favor of a more fecund discussion: the increasingly acknowledged potential for use as a viable form of risk securitization and lending.

Before one enters into discussion regarding the nebulous system, a proper definition is seemingly necessary. Shadow banking, however, is difficult to define, and for obvious semantic reasons (i.e. the signifier “shadow’). The following is taken from The Economist report:

“The definition of shadow banking is itself shadowy. The term was coined in 2007 by Paul McCulley, a senior executive at PIMCO, a big asset manager, to describe the legal structures used by big Western banks before the financial crisis to keep opaque and complicated securitised loans off their balance-sheets, but it is now generally used much more broadly. The Financial Stability Board, an international watchdog set up to guard against financial crises, defines shadow banking as ‘credit intermediation involving entities and activities outside the regular banking system’—in other words, lending by anything other than a bank […] Some of these competitors are simply banks by another name, trying to boost profits by cutting regulatory corners, which is a worry. But most are genuinely different creatures, able to absorb losses more easily than banks. They are a buttress rather than a threat to financial stability.”

Thus, shadow banking isn’t really just a system of recalcitrant competitors belying financial stability. Rather, as the report states, it has become a non-entrained system with all the plenum of traditional finance, now comprising a quarter of the global financial system, with assets reportedly reaching $71 trillion in 2013 –signaling a growth of $26 trillion in the last decade alone.

As I’ve argued before, it’s quite likely we can more readily account for the growth of shadow banking than the system itself, by beginning to think, or rather examine, its attractors as (Deleuzian) singularities. Why? Simply put, unlike the system itself, its basins of attraction are in fact not new at all. Just take, for instance, The Economist’s anecdote of Hall & Woodhouse, an English brewery founded in 1777. Until this year, H&W’s financial activity was a tableau of a “traditional” business that borrowed money in the form of bank loans, and then proceeded to gradually pay back the interest and principal, thus generating revenue, a steady income, a low level of debt, and a “pristine credit record”. Hall & Woodhouse, however, encountered some trouble in 2010 following the financial crisis, when their traditional lender, the Royal Bank of Scotland, informed the business it would only renew their line of credit for three years, instead of the usual five –and notably, now at a higher interest rate. Rather than conceding to this new, more expensive line of traditional credit, Hall & Woodhouse turned to shadow banking.

The Economist reports:

“They decided they needed more reliable long-term creditors, so they reduced their bank borrowing and turned instead to a shadow bank—a financial firm that is not regulated as a bank but performs many of the same functions (see article). The one they picked was M&G (the asset-management arm of Prudential, a big insurance firm), which offered them £20m over ten years.”

The Economist’s narrative here is that shadow banking offered H&W what traditional banks no longer could, or would, thus filling the void. However, this new trajectory, at least in Hall & Woodhouse’s case, is driven by much older, perennial business practices: securitization against risk via cost-effective loans. The attractors for businesses such as Hall & Woodhouse, then, haven’t changed. Shadow banking has been increasingly replacing traditional banks, which are now bogged down by post-crisis regulations and putative risk-minimizing measures. As The Economist puts it, “[t]his retreat of the banks has allowed the shadow banking system to fill the ensuing void.” But are we truly witnessing a meaningful exodus from tradition? The structure of shadow banking paradoxically mimes that of traditional lending, albeit in a more elliptical and unregulated dimension. So increasingly we see the discourse shifting away from oversimplified declamations against shadow banking, towards arguments that borrowers are drawn towards shadow banking because it offers what traditional banks can’t, as these banks are now “beset by heavier regulation, higher capital requirements, endless legal troubles and swingeing fines.” If we examine such activities in finance as Deleuze, and after him Manuel Delanda, conceive dynamical systems –namely, as comprised of trajectories whose basin of attraction are singularities, and wherein shocks or various critical stimuli help account for the creation of a bifurcated systems like shadow banking– this “draw” to the shadows, which accounts for the system’s subsequent growth, increasingly seems obvious.

Today regulators are apparently seeking ways to promulgate the upside of the shadow banking system, their intention being the attenuation of activities potentially leading to future crises, while simultaneously utilizing the system “for good”. Much of their focus, The Economist reports, is on leverage.

“One focus is leverage, the amount an institution has borrowed relative to the amount of loss-absorbing equity its owners have put into it. Most investment funds (with the notable but small exception of hedge funds) have minimal leverage or none at all, so if they run into trouble there is little risk that other lenders will suffer as a result. Alas, such contamination was a much bigger problem for the shadowy vehicles that issued asset-backed securities before the crisis.”

Much of the post-2008 discourse initially painted shadow banking as a principal contributor to the financial meltdown, partly due to the difficulty of evaluating off-balance sheet transactions, which proved so insidious, albeit only after the fact. That being said, we now better understand the cognitive response to post-crisis risk aversion (e.g., Hall & Woodhouse); consequently, we better understand the draw to shadow banking, and we better understand, to some extent, the risks associated with it. As The Economist report observes, “[t]he sooner the regime spells out which assets are protected, the sooner investors will take more care about risk. Shadow banking can make finance safer, but only if it is clear whose money is on the line.” So perhaps the important question here is a Deleuzian inquiry into the potential utilization of this new, bifurcated system of finance, which in turn will require that we move beyond traditional approaches to the topic, and now towards an understanding of the more fungible, even topological form of trading, lending, and securitization that is shadow banking. Indeed, shadow banking has already seemingly proved itself as a viable lending and borrowing tool par excellence in a post-crisis world, comprised of comparatively fewer, if any, nascent, state-violenced regulatory structures. Therefore, the question here is, how do we really wish to utilize such a system that holds the potential for disaster, but, conversely, the potential “for good” –and of course, as always, by what do we mean “good”? Mark Carney of the Financial Stability Board recently described shadow banking as the greatest danger to the world economy. The Economist report, however, is obviously more optimistic (The report celebrates shadow banking, while still betraying some anxiety: “Shadow banking certainly has the credentials to be a global bogeyman. It is huge, fast-growing in certain forms and little understood—a powerful tool for good but, if carelessly managed, potentially explosive.”)

We know shadow banking is inherently elliptical and difficult to map. But viewed through the analytical prism of the Deleuzian ontology, perhaps we will become more capable of mapping its growth, but subsequently must also be willing to then seek out concrete ways for its positive, alternative, even radical utilizations. Most of the discourse surrounding shadow banking articulates a deep and no doubt warranted concern over inadvertently instigating another liquidity crisis-turned-solvency crisis-turned-systemic-crisis. But is it enough for political economy to always concern itself with preempting a repeat of the same mistakes of the past? Is this to be our only vocation? Shadow Banking is indeed, in actuality, relatively new. So far as we seek to draw upon a metricized balance sheet to account for, understand, and regulate the correlative risks represented therein, there does seem to be a common, perhaps warranted, but at any rate apprehension that this system is too vague, nebulous, and potentially threating to system-stability. More proactive, however, may be to continue to prepare our imagination for our financial system’s alternative potential uses in ways that eschew habit and tradition (à laNietzsche). Only then can we thus elude the perpetual, surreptitious introjection of crippling anxiety over ongoing psychological, emotional, and cognitive attachments to traditional practices that vitiate our ability to actualize the virtual potential of finance, which is so necessary for rejecting the trope of insulating security against risk: for perhaps today our true task is to favor expanding universal risk against its perpetual threats by individuated insecurity.

— by Alex Montero

Cited web versions of The Economist report:


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