Definition
Shadow banking refers to the web of financial intermediaries that perform bank-like functions, channeling savings into loans, but fall outside the rules that govern traditional banks. It includes money-market funds, investment funds, broker-dealers, and special-purpose vehicles.
These institutions take in short-term funding and use it to support longer-term lending, much as a bank does, yet they lack deposit insurance and the central bank's lender-of-last-resort backstop.
Why it matters
How it works
Shadow banks raise short-term money, often through repo agreements or money-market funds, and invest it in longer-term assets, frequently securitized loan pools. This maturity transformation earns a spread but creates fragility: if short-term funding dries up, the institution cannot quickly sell its assets.
Because they lack deposit insurance and central-bank support, shadow banks are exposed to runs. In 2008, panic in repo and money markets froze this funding, forcing fire sales and spreading stress across the financial system. Regulators have since worked to monitor and contain these risks.