Financial Bubble: Shadow Banking System Soar to US $67 Trillion or 100% of World GDP

Each bubble carries with them their own individual or distinctive character. Bubbles are hardly identical, except for their monetary origins. 

Prudent Bear’s Doug Noland writes 

The current inflationary boom is unique.  It is global in nature unlike anything previously experienced.  The global Credit Bubble completely engulfed the “dollar reserve” global financial “system.”  The massive inflation of dollar financial claims fomented a corresponding historic inflation in various currency Credit systems worldwide.  Unprecedented global Credit inflation has been fueled by a globalized system of electronic “money” and Credit.  This prolonged cycle has been unique in terms of a global Credit expansion unconstrained by a monetary anchor, gold backing or even restraint imposed by bank reserve and capital requirements.  It’s been runaway non-productive debt growth on a scale never before seen.

Today’s unanchored US dollar standard system combined with the incumbent political economic architecture, which privileges the banking and financial sector, has brought upon the exploding growth of the Shadow Banking system

From Bloomberg,

The shadow banking industry has grown to about $67 trillion, $6 trillion bigger than previously thought, leading global regulators to seek more oversight of financial transactions that fall outside traditional oversight.

The size of the shadow banking system, which includes the activities of money market funds, monoline insurers and off- balance sheet investment vehicles, “can create systemic risks” and “amplify market reactions when market liquidity is scarce,” the Financial Stability Board said in a report, which utilized more data than last year’s probe into the sector…

At $67 trillion this accounts for about 100% of the world GDP

The informal economy should not be seen as similar to the shadow banking system.

The former mostly signifies guerilla capitalism, while the latter has been the consequence of government protected banking and financial institutions taking advantage of legal loopholes (regulatory arbitrage) to financially “engineer” their balance sheets through innovative investment vehicles and accounting maneuvers.

From the same Bloomberg article:

Supervisors consider shadow banking activities to be those that allow banks to carry out business off balance sheets, as well as those which allow investors to bypass lenders and the functions they traditionally fulfill on the markets.

Once concentrated in the US, weak economic conditions and the recent financial crisis has prompted the Shadow Banking system to shift activities the worldwide.

Some highlights from the Financial Stability Board’s Global Shadow Banking Monitoring report 2012 (bold mine)

-Aggregating Flow of Funds data from 20 jurisdictions (Argentina, Australia, Brazil, Canada, Chile, China, Hong Kong, India, Indonesia, Japan, Korea, Mexico, Russia, Saudi Arabia, Singapore, South Africa, Switzerland, Turkey, UK and the US) and the euro area data from the European Central Bank (ECB), assets in the shadow banking system in a broad sense (or NBFIs, as conservatively proxied by financial assets of OFIs) grew rapidly before the crisis, rising from $26 trillion in 2002 to $62 trillion in 2007. The total declined slightly to $59 trillion in 2008 but increased subsequently to reach $67 trillion in 2011.

-Expanding the coverage of the monitoring exercise has increased the global estimate for the size of the shadow banking system by some $5 to 6 trillion in aggregate, bringing the 2011 estimate from $60 trillion with last year’s narrow coverage to $67 trillion with this year’s broader coverage. The newly included jurisdictions contributing most to this increase were Switzerland ($1.3 trillion), Hong Kong ($1.3 trillion), Brazil ($1.0 trillion) and China ($0.4 trillion).  

-The shadow banking system’s share of total financial intermediation has decreased since the onset of the crisis and has been recently stable at a level around 25% of the total financial system, after having peaked at  27% in 2007.  In aggregate, the size of the shadow banking system in a broad sense is around half the size of banking system assets. 

-The size of the shadow banking system (or NBFIs), as conservatively proxied by assets of OFIs, was equivalent to 111% of GDP in aggregate for 20 jurisdictions  and the euro area at end-2011 (Exhibit 2-3), after having peaked at 128% of GDP in 2007

-The US has the largest shadow banking system, with assets of  $23 trillion in 2011 on this proxy measure, followed by the euro area ($22 trillion) and the UK ($9 trillion).  However, its share of the total  shadow banking system  for  20 jurisdictions and the euro area has declined from 44% in 2005 to 35% in 2011. The decline of the US share has been mirrored by an increase in the shares of the UK and the euro area

This shows how deeply interconnected and intertwined the global banking and financial system is. 

This also underscores financial globalization, where the chain link of banking and finance amplifies contagion risks especially from from counterparty risks in the event of defaults.

This is also why central banks will likely keep on inflating as they will likely "move heaven and earth" to prevent the risks of cross-cascading defaults that would collapse the Shadow Banking system (and not to mention the collosal derivatives market which have reached $639 trillion as of June 2012 according to the BIS) and which would translate to a meltdown of the global banking industry and to sovereign defaults.

Current monetary inflation will require significantly more of the same monetary steroids to keep up the illusion of stability, which is why this inflationary boom has been no less different from the Ponzi operations, except that the central bank printing press has been the source of “something for nothing” operations.

Also the expanding depth of financial interdependency  poses limits to ‘decoupling’ or the idea that select national economies can move on a different path or become immune to a crisis.