At the November 2010 Seoul Summit, in view of the completion of the new capital standards for banks (Basel III), the G20 Leaders identified some remaining issues of financial sector regulation that warranted attention. They highlighted “strengthening regulation and supervision of shadow banking” as one of these issues and requested that the Financial Stability Board (FSB), in collaboration with other international standard setting bodies, develop recommendations to strengthen the oversight and regulation of the “shadow banking system” by mid-2011.1The “shadow banking system”, which will be defined in more detail in the next section, can broadly be described as “credit intermediation involving entities and activities outside the regular banking system”. Intermediating credit through non-bank channels can have advantages. For example, the shadow banking system may provide market participants and corporates with an alternative source of funding and liquidity. However, as the financial crisis has shown, the shadow banking system can also become a source of systemic risk, both directly and through its interconnectedness with the regular banking system. It can also create opportunities for arbitrage that might undermine stricter bank regulation and lead to a build-up of additional leverage and risks in the system. Enhancing supervision and regulation of the shadow banking system in areas where systemic risk and regulatory arbitrage concerns are inadequately addressed is therefore important. In response to the G20’s request, the FSB organized a workshop of experts hosted in London on 6 December 2010 to exchange views on the shadow banking system.

The term “shadow banking system” started to be used widely at the onset of the recent financial crisis. The emergence of the term reflected a recognition of the increased importance of entities and activities structured outside the regular banking system that perform bank-like functions. The crisis demonstrated many ways in which shadow banking is interrelated with the regular banking system and can have an impact on global financial stability. While the term is used widely in the news media and in policy discussions, there is as yet no clear commonly agreed definition. This stems not only from its recent origins but also from how the banking sector is structured and regulated in each jurisdiction. Moreover, financial transactions outside the banking sector can be complex and may evolve over time depending on factors such as financial innovation and regulatory changes. A flexible forward-looking perspective is crucial to capture mutations in credit intermediation that can pose risks to the financial system.