Financial Risk Manager Part 1
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In the face of competition from money market funds and junk bonds towards the end of the 20th century, the traditional banking model became less profitable and partly contributed to the emergence of the shadow banking system. This system consisted of a set of institutions which:
Other
Community
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A
Were not only illegal but also engaged in money laundering.
B
Were allowed to invest only in short-term financial assets such as T-bills.
C
Were non-depository, and not subject to banking regulations.
D
Were non-depository, and subject to more stringent regulations compared to banks.
Explanation:
Explanation
The correct answer is C because the shadow banking system refers to financial intermediaries that provide services similar to traditional commercial banks but operate outside the regular banking system.
Key characteristics of shadow banking institutions:
- Non-depository: They do not accept deposits like traditional banks
- Not subject to banking regulations: They operate outside the regulatory framework that governs traditional banks (no reserve requirements, capital adequacy rules, etc.)
- Examples: Money market funds, hedge funds, investment banks, structured investment vehicles
Why other options are incorrect:
- A: Shadow banking is not inherently illegal - it operates in legal gray areas but is not primarily engaged in money laundering
- B: Shadow banking institutions can invest in various assets, not just short-term T-bills
- D: Shadow banking is subject to less regulation, not more stringent regulation compared to traditional banks
The emergence of shadow banking was driven by regulatory arbitrage - institutions sought to provide banking-like services while avoiding the regulatory costs and constraints of traditional banking.
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