The shadow banking system is vastly bigger than regulators had thought, say econophysicists who have developed a powerful new way to measure its hidden impact.
In most parts of the world, the banking system is closely regulated and monitored by central banks and other government agencies. That’s just as it should be, you might think.
But banks have a way round this kind of regulation. For the last decade or so, it has become common practice for banks to do business in ways that don’t show up on conventional balance sheets. Before the 2008 financial crisis, for example, many investment banks financed mortgages in this way. To all intents and purposes, these transactions are invisible to regulators.
This so-called shadow banking system is huge and important. Indeed, many economists blame activities that took place in the shadow banking system for the 2008 crash.
But the size of the system is hard to measure because of its hidden and impenetrable nature. But today, Davide Fiaschi , an economist at the University of Pisa in Italy, and a couple of pals reveal a powerful and simple way of determining the size of the shadow banking system.