FINANCIAL INSTITUTIONS

Shadow Banking, Scheduled and Non-scheduled banks and

Money Supply

SHADOW BANKING:

Shadow banking is a term that is used to describe all financial institutions that perform bank-like
transactions, but are not regulated by one. Due to the unique nature the company was created, these
particular institutions have a significant amount of flexibility when it comes to how they do
business. The shadow banking system also refers to unregulated activities by regulated institutions.
The term was coined by an economist in 2007, when these types of companies were brought into
the spotlight by the upcoming economic crisis. Like traditional banks, shadow banks provide credit
and liquidity but, unlike their traditional counterparts, they do not have access to central bank
funding or safety nets like deposit insurance.

Shadow banking includes money market funds, private equity funds, hedge funds, securitization,
securities lenders, and structured investment vehicles. Broad definitions also include investment
banks and mortgage brokers.

How do shadow banks work?

Shadow banking institutions generally serve as intermediaries between investors and borrowers,
providing credit and capital for investors, institutional investors, and corporations, and profiting
from fees and/or from the arbitrage in interest rates.

Unlike traditional banks, shadow banks do not take deposits. Instead, they rely on short-term
funding provided either by asset-backed commercial paper or by the repo market, in which
borrowers offer collateral as security against a cash loan and then sell the security to a lender and
agree to repurchase it at an agreed time in the future for an agreed price. Shadow banks, which are
often based in tax havens, invest in long-term loans like mortgages, providing credit across the
financial system by matching investors and borrowers individually or by becoming part of a chain
involving numerous entities, some of which may be mainstream banks.

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What are the pros of shadow banking?

The shadow banking system offers credit and also provides liquidity and funding in
addition to that provided by the mainstream banking system.
Given the specialized nature of some shadow banks, they can often provide credit more
cost-efficiently than traditional banks.
The shadow banking system is very important for the economy because it provides
funding to traditional banks and without this funding, traditional banks would not lend
money, which would then slow growth in the wider economy.
Shadow banking institutions like hedge funds often take on risks that mainstream banks
are either unwilling or not allowed to take. This means shadow banks can provide credit
to people or entities who might not otherwise have such access.

What are the risks associated with shadow banking?

As shadow banks do not take deposits, they are subject to less regulation than traditional
banks. They can therefore increase the rewards they get from investments by leveraging up
much more than their mainstream counterparts and this can lead to risks mounting in the
financial system.
Shadow banks' collateralized funding is also considered a risk because it can lead to high
levels of financial leverage.
Unregulated shadow institutions can be used to circumvent the strictly regulated
mainstream banking system and therefore avoid rules designed to prevent financial crises.

Is the shadow banking system regulated at all?

In the United States the Dodd-Frank Act, passed in 2010, made provisions which go some way
towards regulating the shadow banking system by stipulating that the Federal Reserve would have
the power to regulate all institutions of systemic importance.

When Mark Carney was appointed chairman of the FSB in November, he said the global watchdog
might introduce direct regulation of the shadow banking system to tackle the risks moving into
this unregulated sector from the heavily supervised mainstream banking sector.

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He said regulating the shadow banking industry would be a top priority for the board in the coming
months and signaled that the FSB was likely to implement hard rules for activities like
securitization and money market funds, and use registration requirements to ensure more
transparency in others.

MONEY SUPPLY:

The Money Supply refers to the entire stock of currency and other liquid instruments in a countrys
economy as of a particular time. The money supply includes notes, coins and balances that are
kept in savings and checking accounts.

Types of money supply:

M1:

M1 is a measure of the money supply that includes all physical money, such as coins and notes,
demand deposits, checking accounts and Negotiable Order of Withdrawal (NOW) accounts. In
other words, M1 measures the most liquid components of the money supply. It contains money
and assets that can quickly be converted to cash. M1 purely focuses on the role of money as a
medium of exchange. The advent of ATMs and debit cards have meant that bank checking
accounts can now be considered as M1 since it is easy to pull out spendable, liquid currency from
them using ATMs and debit cards. M1 is used to quantify the amount of money in circulation. M1
does not include near money.

M2:

M2 is a measure of money supply that includes all the elements of as well as near money. Near
money refers to savings deposits and other money market instruments such as fixed deposits
which are less liquid. They can easily be converted to cash but are not as suitable as mediums of
exchange mediums due to their less liquid nature. M2 is a broader money classification than M1.
A consumer or business dont pay for, or receive savings deposits during exchange of goods and
services, but could convert M2 components to cash in a short time. M2 is important because
modern economies use cash transfers between different types of accounts. For example, a business
may transfer $10,000 from a money market account to its checking account. M1 and M2 are inter-

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related because a cash transfer can occur between accounts (M2), and this transfer can be cashed
by the recipient in liquid form (M1).

SCHEDULED BANK:

The banks which are registered in the list of central bank under its charter are known as scheduled
banks. They are bound to perform banking services according to the policies and instructions of central
bank.

Example:

National Bank of Pakistan (NBP)

Allied Bank Limited (ABL)
Habib Bank Limited (HBL)
Askari Bank Limited

NON-SCHEDULED BANK:

The banks which are not registered in the list of central bank under its charter are known as non-
scheduled banks. They are not bound to perform banking services according to the policies and
instructions of central bank.

Example:

Bank of Khyber,
Bank of Punjab,
Sindh bank

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Comparison:

Variables Scheduled Banks Non-Scheduled Banks

Clearing facility Clearing facility is available in There is no clearing facility in non-

scheduled bank scheduled banks.
Liability Scheduled liable to follow the Non-scheduled banks they are not
instructions of central bank liable the follow any instruction of
central bank
Registration Registered under the act of 1956 Non-scheduled banks are not
sec 37(1) registered
Share Capital and The share capital and reserves of The share capital and reserves of non-
Reserves scheduled banks are more scheduled banks are less

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