Shadow Banks and the Financial Crisis of 2007-2008
In 'THE BANKING CRISIS HANDBOOK', Chapter 3, pp. 39-56, Greg Gregoriou, ed., CRC Press, 2009
Posted: 20 Mar 2010 Last revised: 29 Dec 2016
Date Written: November 2, 2010
This paper argues that bank runs on the shadow banking system was a significant factor in the spread of subprime losses to the overall financial system. Highly leveraged shadow banks with illiquid assets suffered from the loss spiral effect whereby they were forced to deleverage due to higher margin requirements and falling asset prices. This deleveraging increased margin requirements and reduced asset valuations, thus fueling the next round of the loss spiral. We also show that informational problems, agency issues, the reliance on historical data to estimate future risks, and the lack of a multilateral settlement mechanism contributed to the spread of the financial crisis.
Keywords: Shadow Banking, Financial Crisis, Subprime Crisis
JEL Classification: G10, G14, G20
Suggested Citation: Suggested Citation