The shadow banking system in the United States might not be as large today as regulators and market participants feared, according to a new quarterly index introduced today by the Deloitte Center for Financial Services. However, with regulatory changes and financial innovation looming, the shadow banking system could creep back very quickly, the Deloitte research group cautions.

The Deloitte Shadow Banking Index shows the volatile shadow banking system totaled $9.53 trillion at the end of 2011 ‒ more than 50 percent below its peak in 2008 ‒ and a figure considerably lower than many estimates.

"With other size estimates ranging from $10 to $60 trillion, we think shadow banking is a concept continuing to look for a better definition," said Adam Schneider, the executive director of the Deloitte Center for Financial Services.

"The purpose of the Deloitte Shadow Banking Index ‒ focused on the U.S. market only at this point – is to help define and quantify the sector over time," continues Schneider. "We believe this will allow a better measure of size, importance, effect of market and regulatory actions, as well as a way to assess the potential impact on regulated banking markets."

Key Index findings include:

• Shadow banking in the U.S. reached a peak value of $20.73 trillion in the first quarter of 2008.
• Also during the first quarter of 2008 the traditional banking sector's assets were only about $15 trillion — 28 percent less than shadow banking. At the end of 2011, however, the comparison reversed with assets in the traditional banking sector $8 trillion higher than shadow banking.
• Dramatic growth of the sector occurred between late 2004 (the Index's starting point) and early 2008, increasing nearly two-thirds in size.
• There have been dramatic changes to a number of the Index's components, including money market mutual funds and activities relating to the government-sponsored enterprises. Securities lending is the only activity that is twice the volume today compared to the Index's baseline eight years ago.

"Regulatory headwinds against the shadow banking system will likely be the No. 1 influence in changes that affect the Deloitte Shadow Banking Index's growth or decline," explains Don Ogilvie, the independent chairman of the Center for Financial Services. "Given that major regulatory efforts have either been enacted or are in the works to help reduce the size of this important sector – like the Financial Stability Board's recommendations expected later this year, which we are tracking closely – this is a conversation that the market needs to have."

"This recent decline does not mean that the shadow banking system is unimportant," said Schneider. "It does mean, however, that it is highly dynamic, and operates amid a backdrop of economic volatility, regulation and significant changes already in the banking system."

The Index defines shadow banking to include more than a half-dozen components that make up a market-funded, credit intermediation system involving maturity and/or liquidity transformation through securitization and secured-funding mechanisms. It exists at least partly outside of the traditional banking system and does not have government guarantees in the form of insurance or access to the central bank.

The entities and activities included in Deloitte's definition are: money market mutual funds, asset-backed commercial paper, asset-backed securities, non-agency mortgage-backed securities, collateralized debt obligations, repurchase agreements, securities lending and agency mortgage-backed securities.

"We expect that the components in the index will increase or decrease as new laws and regulations are adopted and as new financial products are created," said Ogilvie.