In Canada the financial services sector weathered the 2007-08 global “credit crunch” better than it did in many other developed countries. One argument for why, certainly in contrast to the U.S., was the smaller size of our “non-bank financial intermediation” sector, more commonly referred to as “shadow banking.” But rapid growth in the shadow sector since the crisis suggests this resilience might be under threat.
On the one hand, then, these financial institutions provide much needed competitive alternatives for both depositors and borrowers. But both because they aren’t as closely regulated as banks and because deposit insurance doesn’t cover their liabilities they might increase overall risk in the financial system. If an NBFI goes down, the damage to the system may well be greater than it was when the shadow institutions were smaller.
In fact, the growth in NBFIs makes a real difference to the effectiveness of monetary policy. Though hikes in the overnight rate do still slow down credit growth, some of that credit now shifts away from traditional banks and toward NBFIs. That is, as funding costs increase for banks, households and businesses move to the shadow sector instead.
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