Part 7/9:
One of the defining characteristics of shadow banking is its reliance on wholesale markets for funding. These funds often come from traditional banking institutions that provide short-term liquidity through mechanisms like repurchase agreements (repo). Shadow banks operate on these markets to leverage their positions and access capital, which can lead to credit expansion, but it also exposes them to the volatility of these markets.
If dealer banks—those that facilitate transactions and liquidity in wholesale markets—become risk-averse or the markets face reduced liquidity, shadow banks could quickly find themselves in precarious situations. The 2008 financial crisis serves as a cautionary tale, with shadow banks contributing to early warning signs through liquidity problems.