Shadow Banking System is essential for Economic Health

Flooding of New System of Shadow Banking parallel to traditional banking system that is essential for government's plan and for keep economy moving forward.

 Something that involves Ninjas. No. But it is something that's concerning the government because the Treasury has put together a plan called the term asset-backed securities lending facility.

Actually, it's been around for a little while, but it's really starting to attract some attention now. And that plan is designed to kind of bail out the shadow banking system. So what is the shadow banking system and why is it so important? So, it acts in parallel to the banking system itself, the banking system proper as we understand it. So how does it work? How the financial sector works?
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Well, let's use an example. Here are let's here's our friend Bruce, okay, and Bruce wants to go out and like many good Americans want to go out and he wants to buy a home. Okay, so the first place that he goes to get the money to buy the home is down the street to his local bank. So here's our bank.

At that banks, people are very nice there and they say, oh, okay, Bruce, you're a good man. And you've got a good credit rating, we can give you a loan at, say 10% or 12%. Okay, so here's his final discount rate at 10%. But Bruce thinks, well, you know, I'll shop around a little bit, if I can get a better rate than that. And because there are various places that he can go, and he can look in what's called the shadow banking market.

Now, we've all heard about these companies that, that provide loans to homeowners that aren't actually banks, these people and it's not just one, not just Home Loans we're talking about, we're talking about credit cards and car loans and all the rest of it student loans.

They're not banks that provide these they're part of the shadow banking system. So Bruce goes to his and let's go, let's call this company nationwide. Okay. So he goes to nationwide and then nationwide system Okay, well there will make your loan at 39%. Okay. So here we have the shadow banking system.

And here we have the banking system, and what difference does it make to Bruce Well, at this point, not that much, Bruce is really just interested in the interest rate, you know, whichever one he chooses, he's going to be getting the same amount of money, although, obviously, the variants and different interest rates, so he's going to be looking for the best rates.

But essentially, his relationship is going to be the same. He's borrowing money, he has to pay it back with interest over a period of time. So why are we so worried about the shadow banking system?

Well, the best thing to do is to have a look at the nature of these two systems, and then we can see where the dangers are and where the concerns lie.

So a bank does business the Traditional Way. It's people save money at the bank. So money goes into the bank, and that money that goes in those deposits, the bank pays a certain amount of interest on say, 2% Okay, then it takes the money, and it lends it at 10% to people like Bruce, okay, and the interest or the spread that's made in between this 8% that's made in between, that is the bank's profit, okay? Which the bank, the bank does, whatever it does with that money. Okay, it's very easy.

What about the Shadow Banking System? Slightly different people are investing money and people are borrowing money via these people like, like our company Nationwide's, but in a slightly different way, whereas in the banking system, you know, Bruce's loan generally is kept on the books of the bank. Hence that doesn't happen with the shadow banking system. What happens is many people like Bruce say there are 100 people like Bruce, who borrowed from nationwide. So it's 100 times Bruce. hmm. Okay. And Lots of these mortgages that he's that they've got now got on their books here that this nation might just put together. What he does is it Securitizers these Okay, it bundles them up.

 You've heard of that term, and it Securitizers them it turns them into bonds. Okay. So see we have our triple-A bonds, double A's, triple B's, double B's, and it goes out to pension funds, and other types of investors hedge funds all the rest of it. So are fun. out here are investors.

It goes out and it says, like, Hey, you guys, you invest money in these. And that's how the money comes into nationwide. So the funds go Okay, well, we'll take triple A's at a 2% double A's at 3%, triple B's 4%, double B is at 5%. Okay, so these are the interest rates based on the risk and this Securitization Instruments.

 So this is the Securitization Process, So essentially, this is the way the money flows in the money flows in via these bonds here from the investors, and then it flows out to borrowers like Bruce. Okay. So obviously a different system.

But what's the fundamental difference here, aside from that, that, that that that difference that I've just pointed out in terms of the way the money is invested? Well, one of the really big differences is in the government involvement. Okay, The banks have been around for a long time.

 And in fact, you know, well, since time infinitude. But over the years in America, the government's been gotten worried about the banks because we have various sorts of crashes and the rest, and they so they put in a system of regulation. So we could call this regulation, I guess you could call it a safety net. So there's a nice big safety net, sitting underneath the banking system.

And the banks have to accord to it in order to make sure that they're safe. And they're things like, capital adequacy, which means that you have to hold a certain amount of money on your balance sheet, depending on how many loans you have. And that's what that does is it makes sure that you're liquid in the event of a disaster. And there are other kinds of checks and balances that are put into a bank business that acts as a safety net.

So the things go wrong with the bank, then then you're caught and the and you're safe. I've had a lot of problems of the banks in the past this way. But what about on the shadow banking side? Well, no regulation, or at least very little regulation. So not much of a safety net. They're not much of a safety net at all. So why is this such a problem? Well, the reason it's such a problem is that the banking system over the years as the economy has gathered pace and more people want to borrow money to do whatever they want to do, whether it be to go to school or buy cars or buy houses or whatever it may be.

The banking system hasn't had the capacity to be able to cope with that demand. And what has happened is that, you know, as the, as the, as the sun has said, if you like on the banking industry over the last few years, the shadow, okay, that the bank has cast, because Securitization has been around for a while, but the shadow that the bank has cast has become a lot larger.

 No, the shadows awfully large. Okay. And in fact, according to some measurements, the shadow is as large as 60% of the business of banking. Okay, so banks lend around 40% of the money in the economy or did before the credit crisis hit the shadow banks.

 The shadow banking system was responsible for 60% of the loans. So now you're starting to see the scale of the problem. Companies like nationwide, these shadow banking companies have been responsible for so much lending, that they've become a key part of the economy.

 In fact, you know, in many ways, you might say, the linchpin (a thing vital to an enterprise or organization.) of the economy. So if they go, if they go down badly, then suddenly you've erased a large proportion of your ability to lend to people and therefore people's ability to buy things and therefore stimulate the economy.

Because there is no safety net, you know, the shadow banking system just goes straight through and craters there on the ground. The reason that's happened is that people have looked at these notes, these bonds that they're spun off from the securities in Securitized Instruments, and they've said, this is toxic waste.

We can't find a way to price this stuff. We don't want to buy it, we don't want to touch it. So if nobody wants to buy any of these bonds, and there's no more of these new Securitization Vehicles being created, and suddenly 60% of your lending business is gone.

So now you can see what the government's getting worried. Because its plan is to get the economy moving again. But people need to be able to borrow in order to do that buying. So what's this towel thing this term is about securities lending facilities supposed to do?

Well, the government's talking about getting people involved to buy these bonds, it wants to create a, almost artificially create a market for these bonds, get people buying them again, get people interested in buying these bonds again, and thereby rejuvenate the market, get this shadow banking market moving again, probably won't be as large as 60%.

You know, it may only be sort of 20% of the market, but they need to get it moving again, because they need to get people like Bruce back in the stores back on the lots back into school, borrowing and stimulate the economy keeping people employed. That's what the government's plan is.

That's why the shadow banking system is essential to the government's plan and why the term asset-backed securities lending facility is so important. Because if the shadow banking system doesn't exist, and we can't keep the economy moving, it's going to leave everybody so the government thinks very badly, needing a drink.

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Beyond Narrative | Blog Where Every Single Word Matters: Shadow Banking System is essential for Economic Health
Shadow Banking System is essential for Economic Health
Flooding of New System of Shadow Banking parallel to traditional banking system that is essential for government's plan and for keep economy moving forward.
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Beyond Narrative | Blog Where Every Single Word Matters
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