Shadow banks are financial institutions which perform some "bank-like" functions, mostly around lending, without the regulatory frameworks of "real" banks.

The classic example might be an investment bank like the demised Lehman Brothers. Lehman would act as a conduit for a loan between an institutional investor like a pension fund and a corporation, for example by repackaging loans and selling them on. 

Other examples of shadow institutions would be Hedge Funds, structured investment vehicles, or special purpose entities.

A "shadow" bank:

  • Operates like a bank: it takes deposits (investments), makes loans (investments), and profits from the interest rate spread (difference) between what it pays depositors and the ROI it is paid by its loans/investments.
  • Is not regulated by the standard commercial bank regulation system.
  • Is not insured by the usual Bank Deposit Insurance system, i.e. the FDIC, and is thus subject to "Bank Runs" if confidence falters or fails.

Posted 3 years, 7 months ago by Stock Guru

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