The Survival Economist: The Truth about the Shadow Banking

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The Survival Economist
Premiered Jul 8, 2021

Since the birth of banking, banks have been at the forefront of risk distribution through diversification and hedging. In the U.S., banks started to sell mortgage-backed debt obligations to investors in the 1960s. The idea was to distribute risk outside the balance sheet of banks, which would make more funds available for lending. This is essentially the point, when ‘shadow banking’ was born.

In the 1990s, diversification and hedging took a big leap forward when the credit default swap, CDS, was developed. In it, the risk of a loan is offset by a third party to which the bank—or, more generally, the issuer of a loan—pays a fee for the insurance.

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