“As hedge funds, private equity firms, and other asset managers that make up the shadow banking system gradually take over the role of lending, their risks—and the borrowed money they use to make them—are largely shielded from view.

“One tension for anyone interested in reforming the financial system is the universal recognition that modern societies need banking. In the truest form, banks take savings deposits and, rather than hiding that money in vaults, lend it out for productive purposes. This provides credit for families, small businesses, corporations, and state and local governments. Without banks, anyone looking to borrow money would have to find their own wealthy individual with extra available cash—and if your last name is not Romney or Rockefeller, that could prove an arduous task. Banks are middlemen, but they serve a vital role that, at its best, complements economic prosperity by making sure the best ideas get the financial support to grow.

“Some U.S. banks, especially at the community level, still employ this basic model today, taking deposits and making loans. But our biggest, Wall Street-centered banks—the ones who hold the majority of the nation’s deposits, slowly consolidating the banking system and growing ever larger—don’t do a whole lot of banking anymore. They tend to focus, instead, on generating profits through a host of other complex methods. But in their absence, lending doesn’t go away; it merely filters down to a different set of less-regulated intermediaries, typically known as the shadow banking sector. (Its nickname perfectly illustrates the core problem with its prominence: anyone concerned about the safety of the financial system does not want its critical activities happening in the shadows.)”

***

Read full Pacific Standard article here