Shadow banking has become a focus of media in the last years, with many headlines on its growing size, its supposed incomprehensible structure and how it was superseding the existing banking system . This view has often been biased toward rejection and misunderstanding. After all, one can argue an independent hedge fund has a better aligned risk-reward structure vs a tax payer propped up bank. (yes, this is an extremely pro-biased view, yes there is a question of size and systemic / structural impact)

Interestingly, the development of shadow banking (broadly) is one of the fundamentals in the development of innovative financial services. A very good example is LendingClub in the US. Structurally, Lending Club is an important securitisation company in the US. Each of the p2p loan is an unsecured obligation from LendingClub with the lenders being the pool of investors. Structurally, it fits very closely the definition of shadow banking.

Other models are being explored, receivables based lending companies are structured using multi compartiments funds, crowdfunding platforms use multiple limited partnerships to simplify the impact of many shareholders on startups (see Fundersclub)

The development of prepaid products as a replacement of banking products can also be seen in the same light. In Europe, for example, the emoney licence is one of the leading platform for innovative financial services. The recent announcement of the Mangopay platform by Leetchi, on the back of of their acquisition of an emoney licence in Luxembourg proves it. In no way this would have been possible if they had pursued a full banking licence.

What is next? There is a risk that the regulator (under various pressure) will want to further restrict these structures (in the name of protecting the consumer). We may see this happening in the US where bank charters have become harder to acquire (Acquiring a bank charter is way harder in most European countries – ask Metrobank)

On the surface, the regulators might be satisfied with this, because the fewer the banks, the more healthy the remaining financial institutions. But this is a fallacy of epic proportions. The lack of bank charters is creating a myopic ecosystem, whereby existing banks — whether they are qualified or not — have an ever-reducing impetus to innovative or improve their service to  customers. Why regulators would want that is beyond me.

I think it is in the best interest of the market if regulators where trying to open the bank market, making it easier to acquire a bank charter (even if limited in some forms in the beginning). Its already fascinating to see the services born out of shadow banking structure, it would be even more interesting how entrepreneurs would leverage a bank charter.