"Bank Soundness Equals Financial Stability No Longer Holds... Shadow Banking Must Be Considered"

A claim has been made that the traditional formula of equating bank soundness with financial stability is no longer valid. This is because the share of assets and loans held by traditional banks is shrinking, while shadow banking is filling the gap. Experts point out that in order for financial authorities and central banks to properly assess and regulate the stability of the financial system, they must look beyond conventional banks and consider the entire ecosystem, including non-depository financial institutions and fintech (finance + technology), which are part of shadow banking.

Amit Seru, a professor at Stanford University, is giving a keynote speech at the World Economists Conference held at COEX in Gangnam-gu, Seoul on the 21st. Photo by Kim Hyemin

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On August 21, Amit Seru, a professor at Stanford University in the United States, attended the World Economists Conference (ESWC) held at COEX in Gangnam-gu, Seoul, and emphasized this point during his presentation in the "Banking and Financial Regulation" session.

Professor Seru explained the results of his analysis of mortgage data across the United States, stating, "Over the past several years, the share of bank loans in the economy has been decreasing, while the share of shadow banking has been increasing." He added, "In particular, 75% of all new real estate loans are now being supplied through shadow banking."

This phenomenon is even more pronounced in regions where bank regulations have been strengthened. He said, "In fact, the stronger the regulations, the smaller the share of banks, and the more clearly shadow banking takes their place." He further explained, "Banks themselves are increasingly originating and selling (securitizing) loans rather than simply holding them, so the proportion of loans on banks' balance sheets continues to decline."

Professor Seru argues that since loan supply has already expanded beyond banks to shadow banking, and banks themselves are selling a greater share of loans, the traditional perspective of assessing financial stability based on the soundness of banks' balance sheets is no longer applicable. He stated, "The formula that bank soundness equals financial stability is no longer valid," and pointed out that failing to see the entire picture could lead to errors in financial and monetary policy.

Professor Seru said, "A new analytical model that encompasses all of these entities is needed." He continued, "Regulatory and monetary policy analysis must move beyond thinking only about banks and expand to the entire system," adding, "It is also meaningful for central banks to shift their stress tests (financial soundness assessments) from just banks to the entire system."

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