Across the world, regulations governing the banking system have been stringent on the premise that depositors’ interests need to be protected. However, under the very nose of the regulators grew an extensive network of a ‘shadow banking system’, comprising hedge funds, private equity and money market funds, broker dealers and structured investment vehicles. This highly leveraged system had an extensive nexus with the banking system. Yet, it suffered much lighter regulation, encouraging the hunt for quick yields and risky financial products. When the systems began to unravel, it was realised that many players in the shadow system posed as much of a systemic risk as banks. The moral of the story is that if an institution is ‘too big to be allowed to fail’, it is also too big to be let off with loose regulations.
Duvvuri Subbarao is Governor, RBI
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