Shadow banking is growing – and it’s a hidden risk to the stability of the financial system

Shadow banking is playing an increasing role in the financial system. Private equity firms, investment funds and mortgage finance companies all employ alternative lending strategies that are lightly regulated, and Canada’s Office of the Superintendent of Financial Institutions is concerned about how much exposure Canada’s banks have to this type of lender, who are collectively known as non-bank financial intermediaries. Their lending is sometimes backed by derivatives, and if their value falls, the loan collateral could be jeopardized. That could have effects for banks who have invested in non-bank financial intermediaries. “If there is a big price move and your trades are levered, you might get a pretty big ask for a margin call, and that effectively can lead to liquidations of positions,” said Patrick Augustin, an Associate Professor of Finance at Desautels. “That can then migrate very quickly to fire sales and big drops in valuations, which might have ripple effects on the economy.”