Shadow Banking, SIVs and Financial Crisis

• Ananth Kumar Reddy

•Shashank Gupta

•Rohit Walimbe

Shadow Banking - Introduction

• What is shadow banking ?

•Financial Intermediaries

• Unregulated activities by regulated institutions

• No traditional bank deposits

Advantages and Disadvantages

• Important role in facilitating Global Credit

• High financial leverage

• Profit gets magnified during booms whereas losses magnify during downturns

Shadow vs. Traditional bank liabilities

SIV – an Introduction

•Structured Investment Vehicle

•Criticized as “ Structured Investment Garbage”

•What is an SIV and where do they come from?

•Who owns them?

•Why do they exist?

• Example – The RhineBridge

SIV – Structure

• Borrow short and lend long

•Get their funds by issuing

commercial paper

•The proceeds are used to

purchase other securities

•Off the banks’ balance

sheet

•Banks last resort to liquidity

providers

http://economistsview.typepad.com/economistsview/2007/09/the-role-of-str.html

Leading to the Nightmare

•No adequate cushion of net equity

•Sharp drop in the prices and market

liquidity of all mortgage-backed securities

•Sharp increase in the price of risk and in

spreads

•Drying-up of the issuance of all asset-

backed securities

•Contagion spread first to a wide class of

commercial paper and then to the money

and interbank markets

Leading to the Nightmare

•Prices and market liquidity of the collateral collapsed

• Refinancing by rolling over the outstanding commercial paper has

become almost impossible

•The committed banks and financial institutions have been required to

provide emergency liquidity.

•Some of the credit risk that was transferred to the market by the banking

system has re-emerged on the banks’ books, straining capital

requirements to an extent depending on the size of the commitment

relative to the assets of the bank

Regulators ….. ????

•“I made a mistake in presuming that the self-interests of organizations,

specifically banks and others, were such as that they were best capable

of protecting their own shareholders and their equity in the firms,” - Mr.

Allen Greenspan

•Reference to central banks’ financial stability reports, Bank of International

Settlements reports, papers of the Financial Stability Forum

•Indeed worried by the vulnerability of the system following a change in risk

appetite and in market liquidity conditions

•Most of their attention was addressed to hedge funds as the banks’ riskiest

counterparties

•Surprisingly, no mention of the potential problems arising from the existence of

off-balance sheet vehicles sponsored and guaranteed by the banks

Aftermath of financial crisis on Shadow banking systems

• Federal Reserve’s emergency liquidity funding helped shadow banks at time crisis but with expiry of these facilities, system is once again operating in margins.

Curing SIVs

Aftermath of financial crisis on Shadow banking systems contd..

• To get to grips with the shadow sector , the regulators

started running a twice a year survey of hedge funds to

assess the risks they pose to the broader system

• Central counterparties-particularly clearing houses are

also targets for regulation – To set new and more

demanding standards for payments, clearing and

settlement systems

Aftermath of financial crisis on Shadow banking systems contd..

• Financial Stability Board , a group of global regulators and

central bankers , set up in 2009 by the Group of 20

countries to spearhead changes to financial rule in the

wake of the crisis

• FSB aims by mid-2011 to draw up “recommendations to

strengthen the regulation and oversight of shadow banking

system”

Thank You