Assessing cross-border interconnectedness between shadow banking systems

Abstract

This paper investigates the interconnectedness among cross-border shadow banking systems using a broad measure of shadow banking defined by the Financial Stability Board. We find that the cross-border linkages between shadow banking systems are tenuous across borders during tranquil periods, but increase significantly in times of tightening global liquidity. These spillover effects can be explained a small number of economy-specific factors, including capital stringency in the banking sector, credit availability in financial markets, investment returns from stocks and bonds, and demand from institutional investors. These factors, however, cannot explain the strong interconnectedness of all regions with North America, hinting that North American economies are the gravity point of global liquidity, which marks the region’s worldwide influence on other shadow banking systems. Our finding highlights the fact that the spillover risk of shadow banking is not limited by national boundaries, which emphasises the need for policymakers and regulators to co-ordinate closely with their foreign counterparts to avoid such risk. The findings also imply that policies should be formulated to mitigate the risk of shadow banking materialising.