Shadow Banking and Securitization
Securitization bundles loans into tradable securities, and the shadow banking system performs bank-like maturity transformation outside regulated banks. Both spread credit widely but proved fragile in 2007 to 2009 because they relied on short-term funding with no deposit-insurance backstop.
Why it matters
Shadow banks borrow short and lend long like banks, but without deposit insurance or a lender of last resort. So a loss of confidence triggers a run on their funding just as a deposit run hits a bank.
Worked examples
Why did the shadow banking system seize up in the 2007 to 2009 crisis?
It funded long-term securitized assets with short-term wholesale borrowing. When the assets fell under suspicion, lenders refused to roll the funding over, a run with no deposit-insurance backstop, and the system froze.
Common mistakes
- ✗Securitization removes risk from the system. It redistributes risk and can hide it, and it concentrated badly when the underlying loans went bad.
- ✗Shadow banks are safe because they are not banks. They do bank-like maturity transformation without the safety net, so they can be more run-prone, not less.
Revision bullets
- •Securitization turns loans into tradable securities
- •Shadow banks transform maturity outside the safety net
- •Run-prone through short-term funding
Quick check
Why is the shadow banking system vulnerable to runs?
Connected topics
Sources
- Mishkin (2018), Ch. 12Mishkin, F. S. The Economics of Money, Banking, and Financial Markets. 12th ed. Pearson, 2018. ISBN 978-1-292-26885-9.Securitization and the shadow banking system in the 2007-2009 financial crisis.