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Assigned Questions:

1. How do the retailing strategies of Sears and Wal-Mart differ?

2. Wal-Mart’s average return on equity for the 1997 fiscal year was 19.7%[$3,525/($18,503+17,143)/2] while Sears’ average return on equity over roughly the same period was 22.0% [$1,188/($5,862+$4,945)/2]. Don Edwards was puzzled by these numbers because of Wal-Mart’s reputation as a premier retailer and Sears’ financial difficulties not long ago. What is driving the performance of these two companies during fiscal 1997?

3. What ratios are most important in assessing current and predicting future value creation for Sears? For Wal-mart?

4. How useful are financial ratios in evaluating the current performance of each of the two companies?

5. How useful are financial ratios in comparing the relative performance of these two companies?

Sears Roebuck vs. Walmart
Havard Business School Case #101-011
Case Software #XLS004
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means—electronic, mechanical, photocopying, recording or otherwise—without the permission of Harvard Business School.
reproduced, stored in a retrieval system or transmitted in any form or by any
f Harvard Business School.
Exhibit 1
Selected Excerpts Sears, Roebuck and Co., 1997 Description of Business
Stores at January 3, 1998:
Leased
Operating Leases
Capital Leases
Independently owned and operated
Dealer stores
Total stores at fiscal year-end 1994
Stores opened during fiscal 1995
Stores closed during fiscal 1995
1995
Stores opened during fiscal 1996
Stores closed during fiscal 1996
1996
Stores opened during fiscal 1997
Stores closed during fiscal 1997
1997
Gross retail area at fiscal year end (square feet in
millions)
1997
1996
1995
Retail selling area at fiscal year end (square feet in
millions)
1997
1996
1995
Retail Store Revenues per Selling Square Foot
1997
1996
1995
$318
$321
$323
Full-line
Stores
460
Auto Stores
Home Stores
Tires
Parts
HomeLife Hardware Dealer Other
598
129
31
13
2
18
Total
1,251
325
48

491
17

486

58
12

228
14

–574
26

1,614
91
574
800
16
(10)
806
27
(12)
821
21
(9)
833
1,007
37
(13)
1,031
40
(13)
1,058
68
(20)
1,106
384
215
(17)
582
67
(22)
627
90
(102)
615
72
26
(1)
97
12
(2)
107
3
(9)
101
80
45
(17)
108
136
(15)
229
33
(7)
255
285
98
(8)
375
120
(26)
469
124
(17)
576
70
7
(6)
71
9
(20)
60
-(16)
44
2,698
444
(72)
3,070
411
(110)
3,371
339
(180)
3,530
110.3
108.4
105.6
15.9
15.2
15.0
6.6
6.9
6.4
3.6
3.8
3.4
8.2
6.1
2.0
4.7
3.8
2.9
1.7
2.0
2.0
151.0
146.2
137.3
71.9
69.9
66.8
2.2
2.1
2.1
4.7
4.7
4.5
3.0
3.2
2.9
6.5
5.6
1.7
3.1
2.6
1.9
1.3
1.5
1.5
92.7
89.8
81.4
Exhibit 2
Sears, Roebuck and Co., 1997 Non-Comparable Items
1997 Net income before noncomparable items
$1,303
$3.27
Reaffirmation charge
SFAS No. 125 accounting change
Sale of Advantis
Other
1997 Net income as reported
(320)
136
91
(22)
$1,188
(0.80)
0.35
0.23
(0.06)
$2.99
Exhibit 3
Sears, Roebuck and Co., 1997 Financial Statements Statements of Income (millions fiscal years ended December 31)
Revenues
Merchandise sales and services
Credit revenues
Total revenues
Costs and expenses
Cost of sales, buying and occupancy
Selling and administrative
Provision for uncollectible accounts
Depreciation and amortization
Interest
Reaffirmation charge
Total costs and expenses
Operating income
Other income
Income before income taxes
Income taxes
Income from continuing operations
Discontinued operations
Net income
1997
1996
1995
$36,371
4,925
41,296
$33,751
4,313
38,064
$31,133
3,702
34,835
26,769
8,331
1,532
786
1,409
475
39,302
1,994
106
2,100
912
1,188
-$1,188
24,889
8,059
971
697
1,365
-35,981
2,083
22
2,105
834
1,271
-$1,271
23,160
7,428
589
580
1,373
-33,130
1,705
23
1,728
703
1,025
776
$1,801
scal years ended December 31)
Exhibit 3
Sears, Roebuck and Co., 1997 Financial Statements Balance Sheets (millions fiscal years ended December 31)
Assets
Current assets
Cash and cash equivalents
Retained interest in transferred credit card receivables
Credit card receivables
Less: Allowance for uncollectible accounts
Other receivables
Merchandise inventories
Prepaid expenses and deferred charges
Deferred income taxes
Total current assets
Property and equipment
Land
Buildings and improvements
Furniture, fixtures and equipment
Capitalized leases
Less accumulated depreciation
Total property and equipment, net
Deferred income taxes
Other assets
Total assets
Liabilities
Current liabilities
Short-term borrowings
Current portion of LT debt and capitalized lease obligations
Accounts payable and other liabilities
Unearned revenues
Other taxes
Total current liabilities
Long-term debt and capitalized lease obligations
Postretirement benefits
Minority interest and other liabilities
Total liabilities
Shareholders’ equity
Common shares ($.75 par value, 1,000 shares authorized
390.9 and 391.4 shares outstanding)
Capital in excess of par value
Retained income
Treasury stock-at cost
Minimum pension liability
Deferred ESOP expense
Cumulative translation adjustments
Total shareholders’ equity
Total liabilities and shareholders’ equity
1997
1996
$358
3,316
20,956
1,113
19,843
335
5,044
956
830
30,682
$660
2,260
20,104
801
19,303
335
4,646
348
895
28,447
487
5,420
4,919
498
11,324
4,910
6,414
666
938
$38,700
445
5,080
4,279
433
10,237
4,359
5,878
905
937
$36,167
$5,208
2,561
$3,533
2,737
6,637
830
554
15,790
13,071
2,564
1,413
32,838
7,225
840
615
14,950
12,170
2,748
1,354
31,222
323
3,598
4,158
(1,702)
(217)
(204)
(94)
5,862
$38,700
323
3,618
3,330
(1,655)
(277)
(230)
(164)
4,945
$36,167
illions fiscal years ended December 31)
Exhibit 3
Sears, Roebuck and Co., 1997 Financial Statements Statements of Cash Flows (millions fiscal years ended December 3
1997
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash provided by (used in)
operating activities
Depreciation, amortization and other non-cash items
Provision for uncollectible accounts
Gain on sales of property and investments
Change in (net of acquisitions):
Deferred income taxes
Retained interest in transferred credit card receivables
Credit card receivables
Merchandise inventories
Other operating assets
Other operating liabilities
Discontinued operations
Net cash (used in) provided by operating activities
Cash flows from investing activities
Acquisition of businesses, net of cash acquired
Proceeds from sales of property and investments
Purchases of property and equipment
Discontinued operations
Net cash used in investing activities
Cash flows from financing activities
Proceeds from long-term debt
Repayments of long-term debt
Increase (decrease) in short-term borrowings, primarily 90 days or less
Termination of interest rate swap agreements
Repayments of ESOP loan
Preferred stock redemption
Common shares purchased for employee stock plans
Common shares issued for employee stock plans
Dividends paid to shareholders
Net cash provided by financing activities
Effect of exchange rate changes on cash and cash equivalents
Net (decrease) increase in cash and cash equivalents
Source: Sears, Roebuck and Co. 1997 Annual Report.
1996
1995
$1,188 $1,271 $1,801
807
1,532
(122)
774
971
(36)
631
589
(35)
273
(31)
50
(1,056) 3,318 (2,036)
(2,285) (5,739)
(534)
(475)
(475)
30
(160)
111
(106)
(258) 1,025
801
–(776)
(556) 1,189
415
(138)
(296)
(53)
394
42
41
(1,328) (1,189) (1,183)
–483
(1,072) (1,443)
(712)
3,920 4,683 2,588
(3,299) (1,832) (1,124)
1,834 (1,814)
(637)
(633)
–16
21
44
-(325)
-(170)
(164)
-103
134
97
(441)
(394)
(607)
1,330
309
361
(4)
(1)
(6)
(302)
54
58
Exhibit 4
Selected Excerpts Sears, Roebuck and Co., 1997 Summary of Significant Accounting Policies
Millions
Investor certificates held by the Company
Contractually required seller’s interest
Excess seller’s interest
Retained interest in transferred credit card receivables
1997
1996
1995
$545
697
2,074
$3,316
$522
684
1,054
$2,260
$295
495
4,789
$5,579
Exhibit 5
Sears, Roebuck and Co., Leased Stores Footnote
Capital Leases (millions)
1998
1999
2000
2001
2002
After 2002
Total minimum payments
Less imputed interest
Present value of minimum lease payments
Less current maturities
Long-term obligation
Source: Sears, Roebuck and Co. 1997 10-K filing.
$59
58
58
57
53
765
$1,050
626
424
14
$410
Operating Leases (millions)
$340
311
268
235
210
1,102
$2,466
Exhibit 6
Sears, Roebuck and Co., 1995-97 Operating Income by Business Format (millions) Fiscal years ended December
Retail
Services
Credit
Corporate
Total operating income
Source:
1997
1996
1995
$946
345
1,005
(214)
$2,082
$867
279
1,164
(216)
$2,094
$703
221
1,001
(197)
$1,728
Sears, Roebuck and Co. 1997 Annual Report.
ons) Fiscal years ended December 31,
Exhibit 7
Sears, Roebuck and Co., 1995-97 Credit Segment Information, Fiscal years ended December 31,
Sears Card as % of sales
Credit card receivables ($ millions)
Provision for uncollectible accountsa ($ millions)
Allowance for uncollectible accountsb ($ millions)
Delinquency as % of end-of year credit card receivablesc
Source:
1997
1996
1995
55.1%
20,956
1,532
1,113
7.00%
56.6%
20,104
971
801
5.40%
56.6%
19,193
589
826
4.16%
Sears, Roebuck and Co. 1997 Annual Report.
a
Provision for uncollectible accounts is also commonly referred to as bad debt expense. This expense is a separate line item
on the income statement and represents the amount of current-period sales that a company feels will not be collected as well
as adjustments in uncollectibility from prior periods (if any).
b
Allowance for uncollectible accounts appears on the balance sheet as a contra asset account to credit card receivables and
measures the amount of credit card receivables that a company feels will not be collected. This account increases as bad debt
expenses are recorded and decreases when uncollectible credit card receivables are written off.
c
An account is generally considered delinquent when the past due balance is three times the scheduled minimum monthly
payment.
Exhibit 8 Wal-Mart Stores, Inc., 1997 Description of Business
Store Count
Fiscal Year Ended
Jan 31
Balance Forward
1993
1994
1995
1996
1997
1998
Wal-Mart Discount Stores
Opened
Closed
Conversionsa
159
141
109
92
59
37
1
2
5
2
2
1
24
37
69
80
92
75
Total
1,714
1,848
1,950
1,985
1,995
1,960
1,921
Wal-Mart Supercenters
Opened
24
38
75
92
105
97
Net Square Footage
Wal-Mart Discount Stores
Wal-Mart Supercenters
Sam’s Clubs
Fiscal Year Ended
Net Additions
Total
Net Additions
Total
Net Additions
Jan 31,
Balance Forward
128,115,368
1,914,246
1993
19,251,060 147,366,428
4,037,493
5,951,739
7,444,530
1994
16,185,442 163,551,870
6,762,080
12,713,819
19,670,804
1995
10,109,978 173,661,848
14,087,725
26,801,544
1,335,742
1996
8,188,223 181,850,071
16,791,559
43,593,103
825,020
1997
(103,486) 181,746,585
19,661,948
63,255,051
298,692
1998
(2,411,149) 179,335,436
17,076,582
80,331,633
716,150
a
Wal-Mart discount store locations relocated or expanded as Wal-Mart Supercenters.
b
Total opened net of conversions of Wal-Mart discount stores to Wal-Mart Supercenters.
c
Includes only stores and clubs that were open at least twelve months as of January 31 of the previous year.
Wal-Mart Supercenters
Total
Opened
10
34
72
147
239
344
441
Sam’s Clubs
Total
23,259,348
30,703,878
50,374,682
51,710,424
52,535,444
52,834,136
53,550,286
Sam’s Clubs
Closed
48
162
21
9
9
8
Total Net
Additions
30,733,083
42,618,326
25,533,445
25,804,802
19,857,154
15,381,583
0
1
12
2
6
1
c
Sq.Ft
153,288,962
184,022,045
226,640,371
252,173,816
277,978,618
297,835,772
313,217,355
Total
256
417
426
433
436
443
Sales Per
Sq.Ft.
325.86
324.42
336.10
335.13
337.35
348.49
Openedb
208
207
304
136
113
81
67
Closed
1
3
17
4
8
2
Total Ending
Balance
1,932
2,138
2,439
2,558
2,667
2,740
2,805
Exhibit 9
Wal-Mart Stores, Inc., 1997 Financial Statements Statements of Income (amounts in millions)
Fiscal years ended January 31,
Revenues:
Net sales
Other income-net
Costs and expenses:
Cost of sales
Operating, selling and general administrative
expenses
Interest costs:
Debt
Capital leases
Income before incomes taxes, minority interest and
equity in unconsolidated subsidiaries
Provision for income taxes:
Current
Deferred
Income before minority interest and equity in
unconsolidated subsidiaries
Minority interest and equity in unconsolidated
subsidiaries
Net income
1998
1997
1996
$117,958 $104,859 $93,627
1,341
1,319
1,146
119,299 106,178
94,773
93,438
83,510
74,505
19,358
16,946
15,021
555
229
113,580
629
216
101,301
692
196
90,414
5,719
4,877
4,359
2,095
20
2,115
3,604
1,974
(180)
1,794
3,083
1,530
76
1,606
2,753
(78)
$3,526
(27)
$3,056
(13)
$2,740
Note: Wal-Mart follows a common retail convention of ending its fiscal year on January 31 of the following
calendar year. This allows the year end to capture all holiday sales and related returns to the stores. Thus, fiscal
1997 ends on January 31, 1998. Sears does not follow this convention.
Exhibit 9
Wal-Mart Stores, Inc., 1997 Financial Statements Balance Sheets (amounts in millions)
Fiscal years ended January 31,
Assets
Current assets:
Cash and cash equivalents
Receivables
Inventories
At replacement cost
Less LIFO reserve
Inventories at LIFO cost
Prepaid expenses and other
Total current assets
Property, plant and equipment, at cost:
Land
Building and improvements
Fixtures and equipment
Transportation equipment
Less accumulated depreciation
Net property, plant and equipment
Property under capital lease:
Property under capital lease
Less accumulated amortization
Net property under capital leases
Other assets and deferred charges
Total assets
Liabilities and shareholders’ equity
Current liabilities:
Accounts payable
Accrued liabilities
Accrued income taxes
Long-term debt due within one year
Obligations under capital leases due within one year
Total current liabilities
Long-term debt
Long-term obligations under capital leases
Deferred income taxes and other
Minority interest
Shareholders’ equity
Preferred stock ($.10 par value; 100 shares authorized, none
issued)
Common stock ($.10 par value; 5,500 shares authorized, 2,241
and 2,285 issued and outstanding in 1998 and 1997, respectively)
Capital in excess of par value
Retained earnings
Foreign currency translation adjustment
Total shareholders’ equity
1998
1997
$1,447
976
$883
845
16,845
348
16,497
432
19,352
16,193
296
15,897
368
17,993
4,691
14,646
7,636
403
27,376
5,907
21,469
3,689
12,724
6,390
379
23,182
4,849
18,333
3,040
903
2,137
2,426
$45,384
2,782
791
1,991
1,287
$39,604
$9,126
3,628
565
1,039
102
14,460
7,191
2,483
809
1,938
$7,628
2,413
298
523
95
10,957
7,709
2,307
463
1,025
224
228
585
18,167
(473)
18,503
547
16,768
(400)
17,143
Total liabilities and shareholders’ equity
$45,384
$39,604
Exhibit 9
Wal-Mart Stores, Inc., 1997 Financial Statements Statements of Cash Flows (amounts in millions)
Fiscal years ended January 31,
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization
Increase in accounts receivable
(Increase)/decrease in inventories
Increase in accounts payable
Increase in accrued liabilities
Deferred income taxes
Other
Net cash provided by operating activities
Cash flows from investing activities
Payments for property, plant and equipment
Proceeds from sale of photo finishing plants
Acquisitions
Other investing activities
Net cash used in investing activities
Cash flows from financing activities
(Decrease)/increase in commercial paper
Proceeds from issuance of long-term debt
Net proceeds from formation of Real Estate
Investment Trust (REIT)
Purchase of Company stock
Dividends paid
Payment of long-term debt
Payment of capital lease obligations
Other financing activities
Net cash (used in)/provided by financing activities
Net increase in cash and cash equivalents
Source:
Wal-Mart Stores, Inc. 1997 Annual Report.
1998
1997
1996
$3,526
$3,056
$2,740
1,634
(78)
(365)
1,048
1,329
20
9
7,123
1,463
(58)
99
1,208
430
(180)
(88)
5,930
1,304
(61)
(1,850)
448
29
76
(303)
2,383
(2,636)
-(1,865)
80
(4,421)
(2,643)
464
-111
(2,068)
(3,566)
–234
(3,332)
-547
(2,458)

660
1,004
-(1,569)
(611)
(554)
(94)
143
(2,138)
564
632
(208)
(481)
(541)
(74)
68
(3,062)
800
-(105)
(458)
(126)
(81)
93
987
38
s (amounts in millions)
Exhibit 11
Lease Note to Financial Statements
Fiscal Year
1999
2000
2001
2002
2002
Thereafter
Total minimum rentals
Less estimated executory costs
Net minimum lease payments
Less imputed interest at rates ranging from 6.1% to 14.0%
Present value of minimum lease payments
Source: Wal-Mart Stores 1997 10-K filing.
Operating Leases
$404
384
347
332
315
2,642
$4,424
Capital Leases
$347
345
344
343
340
3,404
5,123
73
5,050
2,465
$2,585
For the exclusive use of C. Luu, 2021.
UV7199
Oct. 3, 2016
GE and the Shadow Banking Landscape
Well, my plan is more comprehensive. And frankly, it’s tougher because of course we have to deal with the
problem that the banks are still too big to fail…But we also have to worry about some of the other players—
AIG, a big insurance company; Lehman Brothers, an investment bank. There’s this whole area called “shadow
banking.” That’s where the experts tell me the next potential problem could come from. I want to make sure
we’re going to cover everybody, not what caused the problem last time, but what could cause it next time.
—Hillary Clinton, Democratic presidential candidate1
Shadow banking, as usually defined, comprises a diverse set of institutions and markets that, collectively, carry
out traditional banking functions—but do so outside, or in ways only loosely linked to, the traditional system
of regulated depository institutions. Examples of important components of the shadow banking system include
securitization vehicles, asset-backed commercial paper (ABCP) conduits, money market mutual funds, markets
for repurchase agreements (repos), investment banks, and mortgage companies. Before the crisis, the shadow
banking system had come to play a major role in global finance.
—Ben Bernanke, former chairman, Board of Governors of the Federal Reserve2
On May 13, 2016, Monica Reddy’s manager at Sifnos Capital Management (Sifnos), Tara Baker, approached
her with a slightly bizarre request: “Starting Monday, we’d love to explore this shadow banking space. Think
you could lead the charge?” Reddy was used to ambiguity at the small, upstart suburban DC investment fund.
Baker admitted she got the bright idea from all the public debate between Bernie Sanders and Hillary Clinton
on financial regulatory structures throughout their presidential campaigns. Reddy had seen Hillary Clinton’s
recent Wall Street Reform plan, which pledged to “tackle financial dangers of the ‘shadow banking’ system.”3
Reddy, who had started at Sifnos six months before, spent her first postcollege decade at the U.S.
Department of the Treasury. Although she loved the Treasury Department, she was ready to give the private
sector a shot and wanted a reprieve from policy making. Most of her research at Sifnos thus far dealt with
companies from the “real” side of the economy, a welcome change of pace from her financial markets focus in
years prior. Despite that, it felt good to get an assignment she knew a little bit about. While Reddy had never
1
“CNN Democratic Debate—Full Transcript,” CNN.com, October 13, 2015, http://cnnpressroom.blogs.cnn.com/2015/10/13/cnn-democraticdebate-full-transcript/ (accessed May 13, 2016).
2
Ben S. Bernanke, “Some Reflections on the Crisis and the Policy Response,” speech to the Board of Governors of the Federal Reserve System,
April 13, 2012, https://www.federalreserve.gov/newsevents/speech/bernanke20120413a.htm (accessed May 13, 2016).
3
Hillary Clinton, “Wall Street Reform,” Hillaryclinton.com, https://www.hillaryclinton.com/issues/wall-street/, (accessed May 13, 2016).
This public-sourced case was prepared by George (Yiorgos) Allayannis, Professor of Business Administration, and Jeffrey Allen (MBA ’16). It was written
as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Names of characters and the company
for which those characters work are fictional. Copyright  2016 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights
reserved. To order copies, send an e-mail to sales@dardenbusinesspublishing.com. No part of this publication may be reproduced, stored in a retrieval system, used in a
spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation.
This document is authorized for use only by Chau Luu in FIN 4438 Bank Management taught by Shen Zhang, Troy University from Feb 2021 to Aug 2021.
For the exclusive use of C. Luu, 2021.
Page 2
UV7199
worked directly on shadow banking issues, the topic had been ubiquitous in public policy circles since the global
financial crisis (GFC), and she had plenty of resources on which to draw.
Notwithstanding the renewed public interest on the matter, Reddy was skeptical as to whether there were
well-informed conceptions regarding the state of shadow banking. To be sure, she knew the sector had recently
gained steam internationally. However, the classic conception of shadow banking in the United States that she
heard described in so many postcrisis policy speeches had become less popular.4 Further, she was slightly
troubled by the harsh dialogue surrounding shadow banking, as the industry was certainly capable of providing
healthy competition with traditional banking and filling gaps in underserved markets. In fact, Reddy recalled
that a contingency of policy makers insisted on referring to the industry as “market-based finance,” refusing
the pejorative nature of the “shadow” adjective.5 On a similar note, it seemed that a single comprehensive
shadow bank regulatory framework could not keep pace with the industry’s dynamism and innovation. One
resource would be critical in getting to the bottom of all this—the Financial Stability Board’s (FSB’s) 2015
Global Shadow Bank Monitoring Report.6 She had browsed a couple of the reports in years prior but never in
excruciating detail.
Rather than simply describing the state of the industry, Reddy knew that Baker would want everything
couched with a certain company in the background. She had been thinking about a headline that flashed across
her Morning Money news feed on March 31, 2016, which read “MetLife Beats FSOC!”7 Immediately her focus
shifted to another company, and she realized this assignment was going to be a fantastic blend of the real and
financial sides of the economy. Reddy pulled up EDGAR and grabbed the 2015 10-K for one of the world’s
oldest industrial companies—General Electric (GE)—the parent company of GE Capital, the institution she
had in mind. In doing so, a few primary objectives came to Reddy’s mind. First, she was particularly interested
in evaluating GE CEO Jeff Immelt’s 2015 decision to divest the vast majority of GE Capital. Second, she
wanted to form an opinion regarding the divestiture’s impact on GE returns moving forward, a projection that
was critical to her investment research. Finally, and perhaps most importantly, she was interested in evaluating
whether GE Capital did indeed fit the characteristics of a shadow bank. Much of her analysis hinged on a better
understanding of this so-called shadow banking industry itself. Thus she turned her attention to that task.
The Shadow Banking Industry
Reddy had seen the advent of the term “shadow banking” attributed to PIMCO economist Paul McCulley
and traced back to 2007 in countless post-GFC analyses of the system.8 However, thorough explanations of
the system’s function and makeup before the GFC were tough to discover. She recalled one speech delivered
by then-president of the Federal Reserve Bank of New York, Tim Geithner, in June 2008, before the onset of
the U.S. financial meltdown, as one of the earlier public analyses of the industry. Without explicitly mentioning
4 Daniel K. Tarullo, “Thinking Critically about Nonbank Financial Intermediation,” speech at The Brookings Institution, November 17, 2015,
https://www.federalreserve.gov/newsevents/speech/tarullo20151117a.htm (accessed May 17, 2016).
5 “Global Shadow Bank Monitoring Report 2015,” Financial Stability Board, November 12, 2015, http://www.fsb.org/2015/11/global-shadowbanking-monitoring-report-2015/ (accessed May 14, 2016).
6 The Financial Stability Board (FSB) was the G-20 body responsible for monitoring global financial stability and coordinating the development of
international regulatory standards for addressing financial stability issues across member jurisdictions. Through the FSB, finance ministries and regulators
from international jurisdictions come together to draft minimum standards, which are ideally implemented by participating members in their domestic
legal and regulatory structures. In 2016, the FSB was chaired by Bank of England Governor Mark Carney.
7 Ben White, “Morning Money,” Politico, March 31, 2016, http://www.politico.com/tipsheets/morning-money/2016/03/morning-money-213502,
(accessed May 13, 2016).
8 See, for example, Bryan J. Noeth and Rajdeep Sengupta, “Is Shadow Banking Really Banking?,” Federal Reserve Bank of St. Louis, October 2011,
https://www.stlouisfed.org/publications/regional-economist/october-2011/is-shadow-banking-really-banking (accessed May 14, 2016).
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shadow banking, Geithner discussed “dramatic growth in the share of assets outside the traditional banking
system,” in which “the scale of long-term risky and relatively illiquid assets financed by very short-term
liabilities” made the system highly susceptible to banklike runs.9
Although pre-GFC discussions of shadow banking were lacking, there was certainly no shortage of
public dialogue on the industry in the aftermath of the GFC. Reddy reexamined one of the original FSB
background notes on shadow banking from 2011, which broadly identified shadow banking as “the system of
credit intermediation that involves entities and activities outside the regular banking system.”10 The FSB further
determined that while regulators should certainly monitor the broad universe of nonbank financial
intermediaries, a more concentrated conception of shadow banking was in order. Thus it formed the narrow
definition of shadow banking as “a system of credit intermediation that involves entities and activities outside
the regular banking system, and raises i) systemic risk concerns, in particular by maturity/liquidity
transformation, leverage and flawed credit risk transfer, and/or ii) regulatory arbitrage concerns.”11 Reddy
determined she would revisit some of these concepts shortly when she started thinking about risks in the system.
For now, she was still concerned with zeroing in on what financial entities this system comprised.
Reddy always pictured the core of the shadow banking system, at least in the United States, to revolve
substantially around the interaction of the “originate-to-distribute” model of credit intermediation and the
securitization market. She recalled, for example, the practice of large, nonbank mortgage companies originating
mortgage loans, then subsequently turning those loans over to the securitization process, which was facilitated
by government-sponsored enterprises (GSEs), investment banks, and special-purpose and structuredinvestment vehicles (SPVs, SIVs). Reddy further recollected insurance companies being tied up in the process
by issuing credit-risk guarantees. The system seemed also to involve money market mutual funds (MMMFs),
hedge funds, and other financial institutions that got their hands on some of the by-products of the process,
such as mortgage-backed securities (MBSs) and commercial paper. In this sense, shadow banking appeared to
be more of a process involving numerous players rather than revolving around any one type of institution.
Actually, she remembered attending a 2012 conference where then-chairman of the Federal Reserve, Ben
Bernanke, relayed a helpful example of the process she had in mind. Conveniently, the FSB included a visual
depiction of this procedure in its 2011 report, which she reformulated and paired with Bernanke’s description
(Exhibit 1).
Scope and Trends
Despite some emerging clarity surrounding the nature of shadow banking, Reddy still felt that she had not
established a thorough understanding of the scope of the system. In reviewing her FSB materials, it seemed
that a working proxy for the scope of shadow banking before 2015 was the group of institutions known as
“other financial intermediaries” (OFIs).12 Data suggested that assets of OFIs had grown substantially since 2002
(Exhibit 2). Notably, however, there was a distinct dip in OFIs in 2008, owing most likely to the collapse of
many nonbank financial structures in the United States around that time.
9 Timothy F. Geithner, “Reducing Systemic Risk in a Dynamic Financial System,” speech at the Economic Club of New York, June 9, 2008,
https://www.newyorkfed.org/newsevents/speeches/2008/tfg080609.html (accessed May 14, 2016).
10 “Shadow Banking: Scoping the Issues,” Financial Stability Board, April 12, 2011, http://www.fsb.org/2011/04/shadow-banking-scoping-theissues/ (accessed May 14, 2016).
11 http://www.fsb.org/2011/04/shadow-banking-scoping-the-issues/.
12 The FSB defined OFIs as “all financial intermediaries that are not classified as banks, insurance companies, pension funds, public financial
institutions, central banks, or financial auxiliaries.” http://www.fsb.org/2015/11/global-shadow-banking-monitoring-report-2015/.
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This concept of OFIs seemed consistent with the FSB’s broader definition of shadow banking. However,
there had to be a separate quantification associated with the FSB’s narrower definition. And indeed, in its 2015
Global Shadow Bank Monitoring Report, the FSB published an “economic functions approach” to identifying
shadow banking activities, which classified those types of financial activities that fulfilled the narrow
definition.13 Reddy made note of these economic functions, their descriptions, and their typical entity types
(Exhibit 3). Additionally, she reviewed data breaking down the share of shadow banking assets by economic
function (Exhibit 4), along with the growth in shadow banking consistent with the narrower scope (Exhibit 5),
and the distribution of worldwide financial assets among banks, OFIs, and shadow banks (Exhibit 6).
Unfortunately, the FSB could only trace data for the narrow measure back to 2010. Nevertheless, the data
seemed to run counter to some of the commonly held beliefs about shadow banking. Trends in the United
States may have influenced the landscape because the United States maintained by far the largest share of global
shadow banking assets (Exhibit 7). After the GFC, however, one of the most significant drivers of shadow
banking growth—U.S. consumer credit—stalled significantly (Exhibit 8). Conversely, China’s share of
worldwide shadow banking assets had grown markedly (Exhibit 7). In fact, Reddy had reason to believe the
FSB’s data underrepresented shadow banking activity in China. Due to a definitional discrepancy, China’s FSB
shadow banking data represented purely OFIs.14 Meanwhile, Reddy knew that Chinese shadow banking was
linked primarily to banks engaging in off–balance sheet activities. Specifically, a large portion of shadow banking
activity had been generated by banks or trust companies offering wealth-management products (WMPs) to
yield-starved investors and lending directly to small and medium enterprises (SMEs) or entrepreneurs, who
might not otherwise fit state-mandated lending requirements.15 Chinese OFIs, therefore, did not capture the
full shadow banking landscape.
The FSB’s data was a start in understanding the scope of and trends in the shadow banking sector, but
Reddy was well aware that one of the big challenges in this arena revolved around data reliability. Many of the
institutions that operated in this space did not have regulatory or public company reporting requirements. In
fact, a Federal Reserve official had conceded that regulators’ “view of developments” in “the shadow banking
sector—remains incomplete.”16 In any case, Reddy believed she had a decent grasp on the general nature of
the shadow banking industry. Now, she wanted to more fully examine the typical business model the industry
pursued.
The Business Model17
To understand the shadow banking business model, Reddy thought it wise to revisit the nature of traditional
banking. At the most basic level, traditional banks intermediated between individual lenders and borrowers.
Individuals typically could not lend directly to borrowers due to liquidity, timing, and informational constraints.
The bank filled this gap by pooling deposits, of which they only needed to keep a fraction on hand, and seeking
to find creditworthy borrowers who could put the funds to productive use. In this manner, banks engaged in
http://www.fsb.org/2015/11/global-shadow-banking-monitoring-report-2015/.
The FSB noted in its monitoring report that China disagreed with the characterization of shadow banking activities, and, therefore, its shadow
banking data was purely a reflection of its OFI activity. http://www.fsb.org/2015/11/global-shadow-banking-monitoring-report-2015/.
15 Wei Jiang, “The Future of Shadow Banking in China,” Columbia Business School: Jerome A. Chazen Institute of International Business, 2015,
http://www8.gsb.columbia.edu/chazen/globalinsights/sites/globalinsights/files/Shadow%20Banking%20in%20China_Chazen%20Institute.pdf
(accessed May 15, 2016).
16 Stanley Fischer, “Financial Stability and Shadow Banks: What We Don’t Know Could Hurt Us,” speech at the 2015 Financial Stability Conference,
December 3, 2015, https://www.federalreserve.gov/newsevents/speech/fischer20151203a.htm (accessed May 16, 2016).
17 Unless otherwise noted, concepts in this section are derived from https://www.stlouisfed.org/publications/regional-economist/october-2011/isshadow-banking-really-banking.
13
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maturity and liquidity transformation.18 In the absence of backstops, market uncertainty could result in bank
runs and fire sales. As an example, if a significant number of depositors withdrew their money at the same time,
banks might need to liquidate assets to meet redemptions, which they may only be able to do at suppressed
prices. This could ripple throughout the financial system, causing widespread asset price declines. To prevent
such market panic, many countries established certain financial stability protections, such as deposit insurance,
central bank liquidity backstops, and consolidated supervisory structures geared toward preserving the safety
and soundness of banking entities.
Although the nature of shadow banking appeared similar to traditional banking, a few significant
differences stuck out to Reddy. First, while both traditional and shadow banks were in the business of extending
credit, it certainly seemed that the shadow banking industry was averse to holding loans to maturity, relying
instead heavily on securitization and the originate-to-distribute model of lending. The second difference
revolved around shadow banks’ exposure to government oversight and safety nets: they seemed to have little
to no exposure in either of these areas. To be sure, some were regulated for various aspects of their business,
particularly to the extent that they were dealing in securities. However, only commercial banks were subject to
a comprehensive, prudential bank supervision regime. Critically, shadow banks also did not have access to
deposit insurance that could help prevent runs and fire sales. The other major difference existed in shadow
banks’ funding models. Nearly every resource Reddy consulted highlighted shadow banks’ reliance on shortterm wholesale funding markets. Bernanke, for instance, posited that shadow banks relied on “various forms
of short-term wholesale funding, including commercial paper, repos, securities lending transactions, and
interbank loans.”19 Reddy knew that traditional banks used these funding sources as well, but it seemed that the
shadow banking system was particularly reliant on them, given its inability to take on deposits. To think more
clearly about these distinct funding arrangements, Reddy gathered her thoughts into a diagram illustrating an
example of a repo transaction, which she viewed as a common example of these short-term wholesale funding
streams (Exhibit 9). Clearly, there seemed to be risks involved in all of this, and Reddy would soon investigate
those. However, she was still not convinced that she fully understood why these institutions existed in the first
place—a matter that lay at the heart of her analysis.
Why Do Shadow Banks Exist?
The FSB suggested that “non-bank financing provides a valuable alternative to bank funding and helps
support real economic activity.”20 To Reddy, it seemed that the shadow banking industry could indeed be a
highly valuable source of financial innovation, competition, and diversification, with the ability to lower costs
across the financial system.21 Perhaps most importantly, the industry appeared to fill significant gaps in the
financial system with both sides of its balance sheet. Certainly she understood the enhanced access to credit the
shadow banking system could provide, but the benefits of the industry’s funding model seemed less obvious.
Thus she began her analysis there.
In many economies, cash-rich entities, such as corporations and pension funds, have relatively few safe and
logical places to store their excess funds. Using the United States as an example, deposit insurance limits often
18 Maturity and liquidity transformation involve the use of shorter-term and more liquid funds, such as deposits, to finance longer-term and more
illiquid assets, such as loans. http://www.fsb.org/2011/04/shadow-banking-scoping-the-issues/.
19 https://www.federalreserve.gov/newsevents/speech/bernanke20120413a.htm.
20 “Transforming Shadow Banking into Resilient Market-Based Finance: An Overview of Progress,” Financial Stability Board, November 12, 2015,
http://www.fsb.org/2015/11/transforming-shadow-banking-into-resilient-market-based-finance-an-overview-of-progress/ (accessed May 17, 2016).
21 https://www.stlouisfed.org/publications/regional-economist/october-2011/is-shadow-banking-really-banking.
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deterred such entities from simply placing their money in bank accounts.22 The FDIC insurance limit was
$100,000 until October 2008, at which point the limit was temporarily raised to $250,000 and then permanently
set to that level in 2010.23 As a further complication, until 2011, banks were prohibited from offering interest
on checking accounts, which served as a further deterrent to large cash-holders placing money in the traditional
banking system.24 Thus the shadow banking system emerged as a channel for cash-rich investors to store their
money, particularly through investing in commercial paper, participating in repo transactions, or placing their
funds with MMMFs, while earning some return and preserving demand-like features of deposits.25 Meanwhile,
on the credit side, Federal Reserve Governor Daniel Tarullo described shadow banks’ role: “Nonbank
intermediaries can also provide credit to borrowers that are underserved or unserved by traditional banks.”26
This property of shadow banking seemed especially important at present, given the lack of credit growth
following the GFC and the anecdotes Reddy constantly heard related to the difficulty SMEs faced in obtaining
financing for growth. In fact, she had read about some innovative attempts by hedge funds and private equity
groups to create “specialized loan funds” geared toward midmarket businesses, one of which was created by
the DC private equity powerhouse the Carlyle Group.27
Reddy believed that the innovative and dynamic properties of shadow banking were the key to unlocking
the competition, credit access, diversification benefits, and cost reduction the industry could offer. It seemed
that the shadow banking industry was simply more nimble, dealt with less bureaucracy, and was more open to
taking advantage of technology than the traditional banking sector. A prime example of this was the ongoing
revolution in financial technology and the rise of online marketplace lending. Reddy had heard of a few of these
entities, such as Lending Club, SoFi, and OnDeck. Her former employer, the Treasury Department, recently
released an interesting white paper investigating the benefits and risks of such developments. Its description of
the industry was intriguing:
Advances in technology and data availability are changing the way consumers and small businesses
secure financing. Leveraging these developments, online marketplace lenders offer faster credit to
consumers and small businesses. Over the past ten years online marketplace lending companies have
evolved from platforms connecting individual borrowers with individual lenders, to sophisticated
networks featuring institutional investors, financial institution partnerships, direct lending, and
securitization transactions.28
This was precisely the type of financial innovation Reddy had in mind when she considered the agility and
dynamism of shadow banking. Of course, as with all opportunities in the financial arena, online marketplace
https://www.stlouisfed.org/publications/regional-economist/october-2011/is-shadow-banking-really-banking.
“Basic FDIC Insurance Coverage Permanently Increased to $250,000 per Depositor,” FDIC press release, July 21, 2010,
https://www.fdic.gov/news/news/press/2010/pr10161.html (accessed May 17, 2016).
24 Banks were prohibited from offering interest on demand deposits until Dodd-Frank (2011) repealed the standard set by Glass-Steagall in 1933. The
measure was designed to prevent banks from competing heavily on deposit accounts and putting the short-term funding to use in equity markets, which
was believed to be a cause of the 1929 market crash. https://www.stlouisfed.org/publications/regional-economist/october-2011/is-shadow-bankingreally-banking;
Dodd-Frank
Wall
Street
Reform
and
Consumer
Protection
Act,
Section
627,
July
2010,
https://www.govtrack.us/congress/bills/111/hr4173/text (accessed May 17, 2016); “What is Regulation Q? Why Was it Repealed?,” FinRegHQ, July
5, 2016, http://www.finreghq.com/articles/regulation-q-repealed-reg-q-provides-exceptions/ (accessed July 9, 2016).
25
Demand-like
features
referred
to
the
ability
to
easily
withdraw
money,
with
little
to
no
restriction.
https://www.stlouisfed.org/publications/regional-economist/october-2011/is-shadow-banking-really-banking.
26 https://www.federalreserve.gov/newsevents/speech/tarullo20151117a.htm.
27 Carlyle GMS Finance defined mid-market companies as those with EBITDA between $10 and $100 million. Carlyle GMS Finance, Form 10-Q,
https://www.sec.gov/Archives/edgar/data/1544206/000119312516584027/d357694d10q.htm (accessed May 17, 2016); “Global Shadow Bank
Monitoring Report 2013,” 41–42, Financial Stability Board, November 14, 2013, http://www.fsb.org/wp-content/uploads/r_131114.pdf (accessed May
17, 2016).
28 Dan Cruz, “Opportunities and Challenges in Online Marketplace Lending,” United States Department of the Treasury, May 10, 2016,
https://www.treasury.gov/connect/blog/Pages/Opportunities-and-Challenges-in-Online-Marketplace-Lending.aspx (accessed May 17, 2016).
22
23
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lending carried risks. Treasury was apt to point out that beyond having minimal regulatory oversight, these
lenders had grown up in an era of low interest rates, and their credit demand had yet to be tested in a downward
cycle.29 It was uncertain how these business models would perform in downward credit cycles or higherinterest-rate environments; in the words of Jamie Dimon, CEO of JPMorgan Chase & Co., “If they have to
borrow in the marketplace with individuals, hedge funds or securitized markets, they won’t be there in tough
markets.”30 Nevertheless, these and other institutions that emerged in recent years demonstrated the role,
benefits, and economic function of the shadow banking industry. Despite these benefits, so much of the
literature Reddy examined focused on the substantial risks of shadow banking, which explicitly came to fruition
during the GFC. As such, she could not formulate a complete picture of shadow banking without deepening
her understanding of these risks.
Risks of the Shadow Banking Industry
Reddy felt that she had already developed some notion of shadow banking risks in exploring the business
model. In a recent speech, Tarullo summarized the basic idea, explaining, “What we might refer to as the
prototypical form of shadow banking presented the kind of risk associated with traditional banking prior to the
creation of deposit insurance—that of destabilizing short-term creditor runs that lead to defaults and asset fire
sales.”31 Having processed numerous perspectives on the risks of the shadow banking sector, Reddy developed
a list of key risks and their associated descriptions (Exhibit 10). All of these risks manifested themselves
intensely in various aspects of the GFC. Reddy recalled a perfect example, for instance, of many of these dangers
at work in the turmoil that struck the MMMF industry. Specifically, she vividly remembered the day the Reserve
Primary Fund, one of the largest and oldest MMMFs “broke the buck.” That is, its net asset value (NAV)
dropped below one dollar due to its heavy exposure to Lehman Brothers commercial paper, the value of which
essentially plummeted to zero upon Lehman Brothers’ collapse.32 To prevent massive runs on the MMMF
industry and ensuing fire sales, the Treasury Department had to step in and temporarily insure MMMFs.33
While she believed her list was a thorough reference for shadow banking risks, Reddy thought two of
these—interconnectedness and regulatory arbitrage—deserved some additional attention, as the terms were
frequently cited in explanations for the GFC. With respect to interconnectedness, policy makers seemed
particularly interested in the degree to which the shadow banking system was interlinked with the formal
banking sector.34 Clearly, the higher degree of interconnectedness, the easier it would be for financial
vulnerabilities to spread throughout the financial sector. Reddy took notice of one such measure of
interconnectedness, the percent of banks’ credit and funding exposure to OFIs, which appeared to have
accelerated dramatically in the years leading up to the GFC but had cooled somewhat since (Exhibit 11). An
example of this on the credit side might involve a commercial bank extending a loan or engaging in a repo with
a shadow banking institution.35 Conversely, on the funding side, a bank might receive a large deposit from a
shadow bank that eclipsed deposit insurance limits.36 Meanwhile, regulatory arbitrage seemed to constitute its
https://www.treasury.gov/connect/blog/Pages/Opportunities-and-Challenges-in-Online-Marketplace-Lending.aspx.
Hugh Son and Jennifer Surane, “Dimon Says Online Lenders’ funding not Secure Enough in Tough Times,” Bloomberg, May 11, 2016,
http://www.bloomberg.com/news/articles/2016-05-11/dimon-says-online-lenders-funding-isn-t-secure-in-tough-times (accessed Aug. 2, 2016).
31 https://www.federalreserve.gov/newsevents/speech/tarullo20151117a.htm.
32 Diya Gullapalli, Shefali Anand, and Daisy Maxey, “Money Fund, Hurt by Debt Tied to Lehman, Breaks the Buck,” Wall Street Journal, September
17, 2008, http://www.wsj.com/articles/SB122160102128644897 (accessed May 18, 2016).
33 U.S. Department of the Treasury, “Treasury Announces Temporary Guarantee Program for Money Market Funds,” September 29, 2008,
https://www.treasury.gov/press-center/press-releases/Pages/hp1161.aspx (accessed May 18, 2016).
34 http://www.fsb.org/2015/11/global-shadow-banking-monitoring-report-2015/.
35 http://www.fsb.org/2015/11/global-shadow-banking-monitoring-report-2015/.
36 http://www.fsb.org/2015/11/global-shadow-banking-monitoring-report-2015/.
29
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own category of risk. Policy makers were concerned with the degree to which shadow banks conducted banklike
activities without being subject to banking supervision.37 This notion was one of the primary drivers of the
“shadow” characterization of the industry. Reddy knew a thing or two about regulation from her days at the
Treasury Department, but even she found the world of shadow banking regulation, or lack thereof, to be highly
confusing. Nevertheless, she believed it was critical to investigate aspects of the shadow bank regulatory
environment, particularly since regulation played an enormous role with her company of interest.
Regulating the Sector
Chairman Bernanke plainly stated, “It is clear that the statutory framework of financial regulation in place
before the crisis contained serious gaps. Critically, shadow banking activities were, for the most part, not subject
to consistent regulatory oversight.”38 But subjecting shadow banking to a comprehensive regulatory regime was
not a simple task. Any regulatory framework would need flexibility to adapt to the remarkable diversity of the
industry while also balancing the potentially competing objectives of financial innovation and financial stability.
Given the dynamism and diversity of the industry, Reddy was skeptical about whether any regulatory structures
could comprehensively keep pace with shadow banking developments. Governor Tarullo seemed to agree:
“Shadow banking is not a single, identifiable ‘system,’ but a constantly changing and largely unrelated set of
intermediation activities pursued by very different types of financial market actors. Indeed, the very rigor of
post-crisis reforms to prudential regulation may create new opportunities for such activities.”39 The post-GFC
years had seen a significant degree of financial reform. Thus far, however, there was no comprehensive regime
for regulating shadow banks. Despite this, there had been a significant number of postcrisis provisions that
regulated activities in the shadow banking field and sought to limit regulatory arbitrage. Reddy catalogued a few
of these shadow banking–related measures (Exhibit 12). One of the provisions, perhaps the only measure thus
far that sought to identify specific nonbank financial entities for enhanced regulation, was particularly important
for her analysis. This was the authority Dodd-Frank conferred upon the Treasury Department’s Financial
Stability Oversight Council (FSOC) to designate certain firms as systemically important nonbank financial
institutions (nonbank SIFIs), thus subjecting them to the Federal Reserve’s Enhanced Prudential Standards
program.40 Only four entities had been designated by FSOC as nonbank SIFIs: AIG, MetLife, Prudential, and
her entity of interest—GE Capital.
GE Capital
Although the origins of GE Capital could be traced back to 1943 under its former existence as GE Credit
Corporation, most analysts placed GE Capital’s true beginning in the 1980s, when then-CEO Jack Welch
sought to diversify the entity’s forays in financial services.41 Indeed, far from simply supporting GE’s industrial
and consumer products businesses, GE Capital grew into a fully diversified financial services organization,
operating in areas that had little to do with GE’s traditional business lines. In its 2007 annual report, GE Capital
confirmed this reality: “Financing and services offered by GE Capital are diversified, a significant change from
the original business of GE Capital, which was financing distribution and sale of consumer products and other
http://www.fsb.org/2011/04/shadow-banking-scoping-the-issues/.
https://www.federalreserve.gov/newsevents/speech/bernanke20120413a.htm.
39 https://www.federalreserve.gov/newsevents/speech/tarullo20151117a.htm.
40 Dodd-Frank Wall Street Reform and Consumer Protection Act, Section 113, July 2010, https://www.govtrack.us/congress/bills/111/hr4173/text
(accessed May 17, 2016).
41 General Electric Capital Corporation (GECC) annual report, 2007; Bouree Lam, “GE’s First Steps Away from Banking,” The Atlantic, June 9, 2015,
http://www.theatlantic.com/business/archive/2015/06/ges-first-steps-away-from-banking/395396/ (accessed May 19, 2016).
37
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GE products. Currently, GE manufactures few of the products financed by GE Capital.”42 Reddy made note
of the array of GE Capital operating areas, which included various forms of commercial and consumer finance
(Exhibit 13). Between 2004 and 2007, it even owned a U.S. subprime mortgage lender.43 GE Capital maintained
that most of its expertise, at least on the commercial side, involved midmarket entities.44 In any case, in 2007,
on the eve of the financial crisis, GE Capital accounted for a remarkable, and perhaps disproportionate, share
of its industrial parent’s operating segment profitability, reaching over 40% in 2007 (Exhibit 14), while
maintaining assets over $600 billion (Exhibit 15). Before investigating recent GE Capital developments that
were fundamental to her analysis of GE’s investment attractiveness, Reddy was interested in examining whether
GE Capital fit the shadow banking characteristics that she had spent all day uncovering.
GE Capital: A Shadow Bank?
It seemed that the going public assumption was that GE Capital was indeed a shadow bank. Nearly every
article that Reddy pulled up regarding GE’s “GE Capital Exit,” a matter she would explore later, referred to
GE Capital as a shadow bank.45 Paul Krugman, the world-renowned economist, perhaps put it the most directly:
“GE Capital was a quintessential example of the rise of shadow banking.”46 Further, on January 8, 2013, GE
Capital was designated as a nonbank SIFI by FSOC, which would subject the entity to a more rigorous banklike
supervisory program administered by the Fed.47 Reddy pulled a number of key passages from the FSOC’s
designation notice for further scrutiny (Exhibit 16). Many of the FSOC’s GE Capital descriptions, including
wholesale funding reliance, leverage, interconnectedness, and risks of fire sales, among others, seemed wholly
consistent with the shadow banking risks cited in the FSB’s and other resources. Reddy confirmed many of
these characteristics through her own scrubbing of GE Capital’s annual reports. Historically, GE Capital’s
reliance on short-term funding (Exhibit 17) and degree of leverage (Exhibit 18) were high, although they each
reached their peak around 2007 to 2008 and had come down substantially since then. Despite these shadow
bank–like characteristics, one piece of the FSOC’s designation notice muddled her thinking. Specifically, the
notice revealed that GE Capital was, in fact, a savings and loan holding company (SLHC), and thereby subject
to consolidated supervision by the Federal Reserve.48 This reality did not seem consistent with the notion that
shadow banks acted outside the purview of consolidated regulation. Reddy would have to spend a little more
time examining the FSOC’s explanation for designating GE Capital as a nonbank SIFI, having recalled there
being some SIFI designation requirement that FSOC consider whether the entity was already prudentially
regulated.49 In any case, Reddy believed the uncertainty surrounding GE Capital’s status as a shadow bank was
General Electric Capital Corporation annual report, 2007.
General Electric Capital Corporation annual reports, 2004 and 2007.
44 General Electric Capital Corporation annual report, 2007.
45 See, for example, Patrick Jenkins, “GE Capital Tells a Cautionary Tale for Shadow Banks,” Financial Times, April 30, 2015,
http://www.ft.com/intl/cms/s/0/802d0aee-dfa7-11e4-a06a-00144feab7de.html#axzz498RcyVuE (accessed May 19, 2016); Paul Krugman, “A Victory
Against the Shadows,” New York Times, April 11, 2015, http://krugman.blogs.nytimes.com/2015/04/11/a-victory-against-the-shadows/?_r=0 (accessed
May 19, 2016); Matt O’Brien, “Financial Reform is Working, Kind of: GE Doesn’t Want to be a Bank Anymore,” Washington Post, April 14, 2015,
https://www.washingtonpost.com/news/wonk/wp/2015/04/14/americas-industrial-giant-is-changing-its-mind-about-being-a-finance-company/
(accessed, May 19, 2016); Justin Fox, “GE Is No Longer a Bank,” Bloomberg, January 15, 2016, https://www.bloomberg.com/view/articles/2016-0115/general-electric-is-no-longer-a-bank (accessed May 19, 2016).
46 http://krugman.blogs.nytimes.com/2015/04/11/a-victory-against-the-shadows/?_r=0.
47 Financial Stability Oversight Council, “Basis of the Financial Stability Oversight Council’s Final Determination Regarding General Electric Capital
Corporation,
Inc,”
July
8,
2013,
https://www.treasury.gov/initiatives/fsoc/designations/Documents/Basis%20of%20Final%20Determination%20Regarding%20General%20Electric
%20Capital%20Corporation,%20Inc.pdf (accessed May 19, 2016).
48 https://www.treasury.gov/initiatives/fsoc/designations/Documents/Basis%20of%20Final%20Determination%20Regarding%20General%20El
ectric%20Capital%20Corporation,%20Inc.pdf.
49 https://www.treasury.gov/initiatives/fsoc/designations/Documents/Basis%20of%20Final%20Determination%20Regarding%20General%20El
ectric%20Capital%20Corporation,%20Inc.pdf.
42
43
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likely characteristic of many entities that were assumed to be part of the industry’s nucleus. The uncertainty
reminded her that any definition of the shadow banking industry would struggle to accurately capture all of the
activities that drove the system. Despite this ambiguity, GE Capital’s parent company, GE, had a plan in the
works to largely eliminate the entity from its operations.
GE Capital Exit Plan
On April 10, 2015, GE announced that it would sell most of GE Capital and return to focusing on its
core industrial businesses. Whatever remained of its financial operations would largely be geared toward
“vertical financing businesses—GE Capital Aviation Services, Energy Financial Services and Healthcare
Equipment Finance,” which had direct connections to its core business.50 In the release, GE explained fairly
directly that “the business model for large, wholesale funded financial companies has changed, making it
increasingly difficult to generate acceptable returns going forward.”51 Reddy wanted to explore this claim more
fully. To do so, she pulled the return on equity (ROE) for GE Capital, the ROE for one of its companion
nonbank SIFIs, MetLife, and the aggregate ROE for commercial banks with assets greater than $100 billion
from 2005 to 2014 (Exhibit 19). The picture was interesting. In general, both GE Capital and MetLife solidly
outperformed comparable commercial banks before the GFC. Since then, ROEs for the three groups had
converged, although MetLife was somewhat volatile. This, to Reddy, seemed to provide a solid argument for
the GE Capital Exit plan, as the entity could no longer outperform traditional banks, which likely maintained
lower cost of funding due to their substantial use of deposit funding, an inexpensive and federally insured
source of funds. Reddy further compared GE’s historical price-to-book ratio to a large commercial bank—
Bank of America (Exhibit 20)—and pulled GE’s historical stock price since 2005 (Exhibit 21), which
collapsed during the GFC, perhaps owing to the weight of GE Capital in GE’s business at the time. Since then,
GE had rebounded progressively. Reddy also thought it would be productive to get a sense for how much
equity GE Capital had tied up in regulatory requirements. Specifically, she measured GE’s common equity tier
1 (CET1) position relative to Basel III requirements (Exhibits 22 and 23).52
It was clear that investors appreciated the exit plan. Upon announcement, GE’s share price jumped nearly
11% (Exhibit 24). As of year-end 2015, GE seemed to be making good on many of its exit plan promises.
Ultimately, it aimed to reduce GE Capital’s assets by $310 billion, while substantially reducing GE Capital’s
reliance on short-term funding and enhancing industrials’ share of profitability to 90% by 2018, among other
targets.53 Reddy took stock of all of the GE Capital dispositions that had occurred thus far. By the end of 2015,
GE Capital’s assets had been reduced by nearly $189 billion, with another $64 billion in scheduled dispositions
(Exhibit 25). Reddy had already noticed the massive reduction in short-term funding reliance that had occurred
over the years (Exhibit 17). GE Capital further detailed in its annual Dodd-Frank–mandated Resolution Plan
that commercial paper issuance had declined to $5 billion, a remarkable drop from its high mark of $101 billion
at the end of 2007.54 There was one last piece of the GE Capital Exit plan that caught Reddy’s eye. The first
page of its original announcement read: “Will work with regulators to terminate GE Capital’s SIFI
50 “GE to Create Simpler, More Valuable Industrial Company by Selling Most GE Capital Assets; Potential to Return More Than $90 Billion to
Investors through 2018 in
Dividends,
Buyback & Synchrony
Exchange,” GE press release, April 10, 2015,
https://www.ge.com/sites/default/files/ge_webcast_press_release_04102015_1.pdf (accessed May 19, 2016).
51 https://www.ge.com/sites/default/files/ge_webcast_press_release_04102015_1.pdf.
52 GE Capital had to abide by all Basel III requirements, except the Global SIFI surcharge, which was reserved for the United States’ largest bank
holding companies.
53 https://www.ge.com/sites/default/files/ge_webcast_press_release_04102015_1.pdf; GE Capital, “2015 Resolution Plan: Public Section,” Federal
Reserve, https://www.federalreserve.gov/bankinforeg/resolution-plans/ge-capital-1g-20151231.pdf (accessed May 19, 2016).
54 https://www.federalreserve.gov/bankinforeg/resolution-plans/ge-capital-1g-20151231.pdf.
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designation.”55 On March 30, 2016, a federal judge overturned MetLife’s designation as a SIFI in a highly
controversial ruling, which engendered the ire of the FSOC and Treasury Department.56 Then, on March 31,
GE made good on its exit plan promise, filing a petition to the FSOC for the abolishment of GE Capital’s SIFI
status.57 All of a sudden, one of the government’s hallmark post-GFC nonbank financial regulatory efforts
appeared feeble. Reddy pulled share prices for each of the SIFIs around the time of all this action and noticed
a distinct jump for MetLife around the March 30 announcement (Exhibit 26).
Reddy was in desperate need of a break. She had consumed a large amount of information on the
shadow banking industry and GE Capital in a very short time period. As usual, however, as she prepared to
embark on her atypical reverse commute back into the city, Reddy had a number of pressing questions on her
mind. First, she wondered what the genuine driving force was behind GE’s decision to dispose most of GE
Capital. Sure, management suggested less-than-satisfactory returns, but Reddy wondered whether that was due
primarily to a synergy discrepancy, a more general business model issue, or a direct result of regulatory costs.
Second, she deliberated what kind of share price bump GE could expect if its designation petition were
successful. Of course, along with that emerged the question as to whether the time was right for Sifnos to get
in on GE stock or whether they had missed out on most of the exit plan–related gains. Reddy would sift
through all of these questions before the night was over. However, she had to admit that one final question
had been lingering in the back of her mind nearly from the minute she opened her FSB resources. As she
glanced around the room at her tiny new company, Reddy wondered whether she, herself, was now working
for a shadow bank.
https://www.ge.com/sites/default/files/ge_webcast_press_release_04102015_1.pdf.
Andrew M. Harris and Katherine Chiglinsky, “MetLife Defeats U.S. Government’s Too-Big-to-Fail Labeling,” Bloomberg, March 30, 2016,
http://www.bloomberg.com/news/articles/2016-03-30/metlife-wins-court-ruling-removing-fsoc-s-too-big-to-fail-tag-imeyio6z (accessed May 19,
2016).
57 Ted Mann, “GE Files to End Fed Oversight after Shrinking GE Capital,” Wall Street Journal, March 31, 2016, http://www.wsj.com/articles/gefiles-to-end-fed-oversight-after-shrinking-ge-capital-1459423851 (accessed May 19, 2016).
55
56
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Exhibit 1
GE and the Shadow Banking Landscape
The Shadow Bank Credit Intermediation Chain
Loan Origination
-Commercial Bank
-Finance Company
(Mortgage, Auto,
Consumer)
Loan
Warehousing
– ABCP Conduits
– SPVs
Securitization
– SIVs
– SPVs
Distribution/
Wholesale
Funding
– MMMFs
– Hedge Funds
– Banks
Liquidity Facilities,
Credit Enhancements
Rating Assignment
-Banks
-Insurance Companies
Credit Rating Agencies
Data source: “Shadow Banking: Scoping the Issues. A Background Note of the Financial Stability Board,” Financial Stability Board, April 12, 2011.
As an illustration of shadow banking at work, consider how an automobile loan can be made and funded
outside of the banking system. The loan could be originated by a finance company that pools it with other loans
in a securitization vehicle. An investment bank might sell tranches of the securitization to investors. The lowerrisk tranches could be purchased by an asset-backed commercial paper (ABCP) conduit that, in turn, funds
itself by issuing commercial paper that is purchased by money market funds. Alternatively, the lower-risk
tranches of loan securitizations might be purchased by securities dealers that fund the positions through
collateralized borrowing using repurchase (repo) agreements, with money market funds and institutional
investors serving as lenders.
—Ben Bernanke, former chairman, Board of Governors of the Federal Reserve1
1 Ben S. Bernanke, “Fostering Financial Stability,” speech to the Board of Governors of the Federal Reserve System, April 9, 2012,
https://www.federalreserve.gov/newsevents/speech/bernanke20120409a.htm (accessed May 13, 2016).
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Exhibit 2
GE and the Shadow Banking Landscape
Worldwide Assets of Other Financial Intermediaries (OFIs)
140
120
100
80
60
40
20
0
$ Trillion
Percent of GDP
Data source: “Global Shadow Bank Monitoring Report 2015: Data on Underlying Exhibits,” Financial Stability Board,
November 12, 2015.
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Exhibit 3
GE and the Shadow Banking Landscape
FSB Economic Function (EF)–Based Approach Definitions
EF #
Description
Entity Types1
1
Collective investment funds that face run risk
Fixed income funds, mixed
funds, credit hedge funds,
real estate funds
2
Direct credit extension models that maintain
substantial short-term funding profiles
Finance companies, leasing
companies, consumer credit
companies
3
Market intermediation models that maintain
substantial client asset secured or short-term
funding profiles
Broker-dealers
4
Financial entities that facilitate credit risk
mitigation or transfer
Credit insurance companies,
financial guarantors
5
Credit intermediation dependent on
securitization mechanism
Securitization vehicles
Other
Residual, unclassified OFI demonstrating
shadow banking characteristics
Data source: “Global Shadow Bank Monitoring Report 2015,” Financial Stability Board, November 12, 2015,
http://www.fsb.org/2015/11/global-shadow-banking-monitoring-report-2015/ (accessed May 14, 2016).
1 FSB footnote 21 in the 2015 Global Shadow Bank Monitoring Report related to “entity types” reads: “The FSB Policy Framework acknowledges
that shadow banking may take different forms across jurisdictions due to different legal and regulatory settings as well as the constant innovation and
dynamic nature of the non-bank financial sector. It also enables authorities to capture new structures or innovations that create shadow banking risks,
by looking through to the underlying economic function and risks of these new innovative structures. Thus the entity types listed should be taken as
typical examples.”
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Exhibit 4
GE and the Shadow Banking Landscape
2014 Share of Shadow Banking Assets by Economic Function (%)
13 (Other)
8 (EF 5)
1 (EF 4)
11 (EF 3)
60 (EF 1)
7 (EF 2)
Data source: “Global Shadow Bank Monitoring Report 2015: Data on Underlying Exhibits,” Financial Stability Board, November 12,
2015.
Note: See Exhibit 3 for economic function definitions.
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Exhibit 5
GE and the Shadow Banking Landscape
Size of the Global Shadow Banking Sector
70
60
57
59
55
55
56
2011
2012
2013
50
40
30
20
2010
$ Trillion
2014
Percent of GDP
Data source: “Global Shadow Bank Monitoring Report 2015: Data on Underlying Exhibits,” Financial Stability Board,
November 12, 2015.
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Exhibit 6
GE and the Shadow Banking Landscape
Worldwide Share of Financial Intermediation Assets (%)
50
45
40
35
30
25
20
15
10
5
0
47
47
46
23
22
23
12
Banks
OFIs
2010
2012
12
12
Shadow banking
2014
Data source: “Global Shadow Bank Monitoring Report 2015: Data on Underlying Exhibits,” Financial Stability Board,
November 12, 2015.
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Exhibit 7
GE and the Shadow Banking Landscape
Largest Shares of Worldwide Shadow Banking Assets (%)
45
40
35
30
25
20
15
End of 2010
10
End of 2014
5
0
Data source: “Global Shadow Bank Monitoring Report 2015: Data on Underlying Exhibits,” Financial Stability Board, November 12, 2015.
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Exhibit 8
GE and the Shadow Banking Landscape
U.S. Household Debt as a Percent of GDP (%)
110
100
90
80
70
60
2015‐Q1
2014‐Q2
2013‐Q3
2012‐Q4
2012‐Q1
2011‐Q2
2010‐Q3
2009‐Q4
2009‐Q1
2008‐Q2
2007‐Q3
2006‐Q4
2006‐Q1
2005‐Q2
2004‐Q3
2003‐Q4
2003‐Q1
2002‐Q2
2001‐Q3
2000‐Q4
2000‐Q1
50
Data source: Bank for International Settlements, “BIS Statistical Warehouse: Long Series on Total Credit,”
http://stats.bis.org/bis-stats-tool/org.bis.stats.ui.StatsApplication/StatsApplication.html (accessed May 15, 2016).
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Exhibit 9
GE and the Shadow Banking Landscape
Short-Term Wholesale Funding: Repurchase (Repo) Market Example
Repo Origination
Repo Maturity
Shadow Bank
Shadow Bank
Cash
Security
Cash Lender
(Money Market Fund,
Bank, Hedge Fund)
Security
Cash +
Interest
Cash Lender
(Money Market Fund,
Bank, Hedge Fund)
Data source: Benjamin Munyan, “Regulatory Arbitrage in Repo Markets,” Office of Financial Research and Vanderbilt University, October 29, 2015, Figure 3,
https://financialresearch.gov/working-papers/files/OFRwp-2015-22_Repo-Arbitrage.pdf (accessed July 9, 2016).
In the repo, or “repurchase,” market, cash investors could purchase short-term securities from shadow
banking issuers with the intent to repurchase them at a later date. Often, the term was overnight. Additionally,
transactions needed not be bilateral as depicted above. Many repo transactions flowed through a central clearing
party, in what was known as the Tri-Party Repo Market. If markets were functioning properly, it was typically
easy to roll over repos on a daily basis, thus creating a stable funding source.1 However, as was the case during
the GFC, market turmoil could cause such markets to freeze up, essentially eliminating a primary source of
shadow bank funding. Such a freeze was possible for any short-term wholesale funding sources, including
commercial paper and interbank loans. For instance, at the apex of the GFC, commercial paper markets
significantly froze, which had a remarkable impact on MMMFs. MMMFs, which the FSB classified as a certain
type of shadow bank, took money directly from savers, investing the funds in short-term, highly liquid, and
presumably safe assets, such as Treasury securities, municipal debt, and commercial paper.2
1 Bryan J. Noeth and Rajdeep Sengupta, “Is Shadow Banking Really Banking?,” Federal Reserve Bank of St. Louis, October 2011,
https://www.stlouisfed.org/publications/regional-economist/october-2011/is-shadow-banking-really-banking (accessed Aug. 22, 2016).
2 U.S. Securities and Exchange Commission, “Money Market Funds,” https://www.sec.gov/spotlight/money-market.shtml (accessed May 17, 2016).
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Exhibit 10
GE and the Shadow Banking Landscape
Shadow Banking Risks
Risk
Description
Redemption/Run Risk
A product of shadow banks’ maturity and liquidity transformation
properties. Run risk represented the potential for shadow banking entities
to experience acute redemptions of funding sources, which were typically
short term and highly liquid or callable.
Fire Sales
Also a product of shadow banks’ maturity and liquidity transformation
properties. Fire sales could ensue from runs as entities liquidate assets to
meet creditor redemptions. If an entity had to liquidate significant
quantities of assets in short order, it had to sell them for suppressed prices,
which generated significant losses. The financial stability concern with fire
sales was that they were widespread enough to cause substantial price
declines.
Leverage
Shadow banking entities were often highly levered, which amplified gains
and losses. Leverage was also cited for causing excessive credit buildup and
accelerating pro-cyclicality.1
Flawed Credit Risk Transfer
Various systems and structures, including securitization and credit-risk
protecting insurance products, such as credit-default swaps, could work to
distort or confuse where credit risk lies.2
Interconnectedness
The risk that linkages between the shadow banking system and other
aspects of the financial sector enhanced risks to the overall financial system.
Concentration Risk
Shadow banking entities were often concentrated in specific areas of credit
intermediation. Lacking diversification, shadow banking entities that were
concentrated in one area could experience significant shocks if a downturn
emerged in that sector. A good example of this revolved around nonbank
mortgage lenders during the GFC. When the housing market collapsed,
losses were heavy for these lenders.
Regulatory Arbitrage
The notion that shadow banking entities aimed to engage in banklike
activities without experiencing the regulatory oversight associated with
banks. Additionally, shadow banking regulatory arbitrage could occur when
banks engaged in off–balance sheet or other transactions that carried lower
or no regulatory oversight and capital provisions.
Data source: Unless otherwise noted, concepts in this exhibit are derived from “Shadow Banking: Scoping the Issues. A Background Note of the
Financial Stability Board,” Financial Stability Board, April 12, 2011.
1 In this context, leverage’s effect on pro-cyclicality referred to its potential to accelerate booms or asset bubbles and magnify the impact of downward
trends. See John Geanakopolos, “The Leverage Cycle,” NBER Macroeconomics Annual 2009, Vol. 24, April 2010,
http://www.nber.org/chapters/c11786.pdf (accessed July 9, 2016); “Shadow Banking: Scoping the Issues. A Background Note of the Financial Stability
Board,” Financial Stability Board, April 12, 2011.
2 “Global Shadow Bank Monitoring Report 2015,” Financial Stability Board, November 12, 2015, http://www.fsb.org/2015/11/global-shadowbanking-monitoring-report-2015/ (accessed May 14, 2016).
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Exhibit 11
GE and the Shadow Banking Landscape
Percent of Bank Assets and Liabilities to Other Financial Intermediaries
10
9
8
7
6
5
4
3
Bank’s funding risk
Bank’s credit risk
Data source: “Global Shadow Bank Monitoring Report 2015: Data on Underlying Exhibits,” Financial Stability Board,
November 12, 2015.
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Exhibit 12
GE and the Shadow Banking Landscape
Examples of Shadow Bank Regulatory Provisions
Provision
Shadow-Banking Related Applicability
Nonbank SIFI Designations
Dodd-Frank established the Financial Stability Oversight Council (FSOC),
which had the authority to designate certain nonbank financial institutions
as systemically significant, thus subjecting these entities to the Federal
Reserve’s Enhanced Prudential Standards.1
Risk Retention
Dodd-Frank required sponsors of securitization products to retain 5% of
the credit risk associated with such products. These were so-called skin-inthe-game requirements.2
Consumer Financial Protection
Bureau (CFPB)
Dodd-Frank created the CFPB, which regulated nonbank consumer
financial entities for consumer protection standards. Although the CFPB
did not regulate nonbank financial entities for safety and soundness, it
nevertheless established some federal oversight for such entities.3
Basel III
Enhanced regulatory capital requirements for securitizations and other
off–balance sheet items to address shadow bank regulatory arbitrage
concerns. Increased regulatory capital requirements for banks’ holding of
exposures to unregulated financial institutions.4
MMMF Reform
The U.S. SEC adopted new rules in 2014 to strengthen MMMF’s
resiliency to run risk.5
Tri-Party Repo Market Reform
The Task Force on Tri-Party Repo Infrastructure, a private body
comprising market participants and sponsored by the Federal Reserve
Bank of New York worked to substantially reduce the volume of intraday
credit in repo markets. The task force also made recommendations to
improve liquidity and risk management in the industry.6
FSB Efforts
The FSB developed a system-wide monitoring framework for worldwide
shadow-banking risks. It also supported policy approaches in member
jurisdictions to reduce interconnectedness, reduce run-risk in MMMFs,
and improve securitization transparency, among other measures.
Source: Created by author.
Dodd-Frank, Section 113.
Dodd-Frank, Section 941.
3 Dodd-Frank, Title X.
4 Tobias Adrian and Adam B. Ashcraft, “Shadow Banking Regulation,” Federal Reserve Bank of New York Staff Reports, April 2012,
https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr559.pdf (accessed May 20, 2016).
5
SEC,
“SEC
Adopts
Money
Market
Fund
Reform
Rules,”
July
23,
2014,
https://www.sec.gov/News/PressRelease/Detail/PressRelease/1370542347679 (accessed May 18, 2016).
6
Task
Force
on
Tri-Party
Repo
Infrastructure,
“Final
Report,”
February
15,
2013,
https://www.newyorkfed.org/medialibrary/media/tripartyrepo/pdf/report_120215.pdf (accessed May 18, 2016); FSOC, 2015 Annual Report,
https://www.treasury.gov/initiatives/fsoc/studies-reports/Documents/2015%20FSOC%20Annual%20Report.pdf, (accessed May 18, 2016).
1
2
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Exhibit 13
GE and the Shadow Banking Landscape
GE Capital Operating Segments (2007)
Segment (subsegment)
GE Commercial Finance
Capital Solutions
Real Estate
Business Focus
Offered loans, leases, and other financial products to manufacturers,
distributors, and other users of equipment and capital assets. Midmarket
focus. Competed with banks, investment banks, leasing companies, and
finance companies.
Focused on financing equipment and capital assets for midmarket players,
particularly in construction, transportation, technology, and manufacturing.
Offered equity and loan products to customers for acquisition or
development of commercial real estate.
GE Money
Consumer and retailer financial services provider. Offerings included
private-label credit cards, personal loans, bank cards, auto loans and leases,
mortgages, debt consolidation, home equity loans, deposit and savings
products, SME lending, credit insurance.
GE Infrastructure
Provided both technologies and financing to develop infrastructure in
global jurisdictions. Focused on aviation, energy, oil and gas, transportation,
and water.
Aviation Financial Services
Provided financial services to airlines, operators, owners, lenders, investors,
and airport developers.
Energy Financial Services
Provided structured equity, debt, leasing, partnership financing, and general
commercial finance to global energy and water industries.
Data source: General Electric Capital Company annual report, 2007.
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Exhibit 14
GE and the Shadow Banking Landscape
Contribution of GE Capital to Total GE Operating Segment Profits (%)
45
40
35
30
25
20
15
10
5
0
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Data sources: General Electric Company annual reports, 2009 and 2014.
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Exhibit 15
GE and the Shadow Banking Landscape
GE Capital Total Assets (Billions)
700
600
500
400
300
200
100
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Data sources: General Electric Capital Company (GECC) annual reports, 2009, 2014; General Electric Company
annual report, 2015.
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For the exclusive use of C. Luu, 2021.
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UV7199
Exhibit 16
GE and the Shadow Banking Landscape
Selected Passages from GE Capital’s FSOC Designation Notice
The Financial Stability Oversight Council (Council) has made a final determination that material financial distress at General
Electric Capital Corporation, Inc. (GECC) could pose a threat to U.S. financial stability…GECC is a significant source of
credit to the U.S. economy, providing financing to both commercial and consumer customers. In 2012, GECC has outstanding
credit to more than 243,000 commercial customers and 201,000 small businesses, as well as credit extended to 57 million
consumers in the United States.
GECC is a significant participant in the global economy and financial markets and is interconnected with financial intermediaries
through its financing activities and its funding model, as well as through other activities in which GECC engages. These activities
include activities in wholesale short-term funding markets, which link GECC to other large financial institutions that are significant
financial intermediaries and with the financial markets more broadly. For example, GECC is a significant issuer of commercial
paper (CP) in the United States. Large global banks and large nonbank financial companies have significant exposure to
GECC…Material financial distress at GECC could trigger a run on MMFs more generally and lead to a broader withdrawal
of investments from the CP market and other short-term funding markets.
GECC holds a large portfolio of on-balance sheet assets comparable to those of the largest U.S. bank holding companies (BHCs).
If GECC were unable to access funding markets, GECC could either reduce its provision of credit or be forced to sell assets quickly
to fund its operations and meet its obligations. If GECC had to rapidly liquidate assets, the impact could drive down asset prices
and cause balance sheet losses for other large financial firms on a scale similar to those that could be caused by asset sales by some
of the largest U.S. BHCs.
GECC is subject to consolidated supervision by the Board of Governors as a grandfathered unitary Savings and Loan Holding
Company that is permitted to engage in commercial activities… Absent a determination by the Council regarding GECC, however,
GECC would not be subject to the enhanced prudential standards…of the Dodd-Frank Act because these standards do not apply
to SLHCs… Furthermore, it is possible that in the future, certain companies may no longer be subject to the Board of Governors’
authority if they successfully deregister as SLHCs. For example, if GECC were to deregister as an SLHC, even though its
subsidiaries would remain subject to other regulatory regimes, the Board of Governors would no longer act as its consolidated
supervisor.
Source: Financial Stability Oversight Committee, “Basis of the Financial Stability Oversight Council’s Final Determination Regarding General Electric
Capital
Corporation,
Inc.,”
www.treasury.gov,
July
8,
2013,
https://www.treasury.gov/initiatives/fsoc/designations/Documents/Basis%20of%20Final%20Determination%20Regarding%20General%20Electric
%20Capital%20Corporation,%20Inc.pdf (accessed Aug. 21, 2016).
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UV7199
Exhibit 17
GE and the Shadow Banking Landscape
GE Capital Short-Term Borrowings
200
35
180
30
160
140
25
120
20
100
80
15
60
10
40
5
20
0
0
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Total Short‐Term Borrowings (billions, left scale)
Short‐Term Borrowings as a Percent of Assets (right scale)
Data sources: General Electric Capital Company annual reports, 2009 and 2014; author calculations.
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Exhibit 18
GE and the Shadow Banking Landscape
GE Capital Financial Leverage (Average Assets/Average Equity, Times X)
11
10
9
8
7
6
5
4
3
2
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Data sources: General Electric Capital Company annual reports, 2005, 2009, and 2014; author calculations.
This document is authorized for use only by Chau Luu in FIN 4438 Bank Management taught by Shen Zhang, Troy University from Feb 2021 to Aug 2021.
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Page 30
UV7199
Exhibit 19
GE and the Shadow Banking Landscape
Return on Equity (ROE) of GE Capital and MetLife Compared to Comparable Banks (%)
25
20
15
10
5
0
-5
-10
2005
2006
2007
GE Capital
2008
2009
2010
2011
2012
Commercial Banks (> $100B)
2013
2014
MetLife
Data sources: General Electric Capital Company annual reports, 2009 and 2014; SNL Financial.
This document is authorized for use only by Chau Luu in FIN 4438 Bank Management taught by Shen Zhang, Troy University from Feb 2021 to Aug 2021.
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Page 31
UV7199
Exhibit 20
GE and the Shadow Banking Landscape
GE and Bank of America Historical Price-to-Book Ratios
4
3.5
3
2.5
2
1.5
1
0.5
0
2006
2007
2008
2009
2010
General Electric
2011
2012
2013
2014
2015
Bank of America
Data source: Morningstar.
This document is authorized for use only by Chau Luu in FIN 4438 Bank Management taught by Shen Zhang, Troy University from Feb 2021 to Aug 2021.
For the exclusive use of C. Luu, 2021.
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UV7199
Exhibit 21
GE and the Shadow Banking Landscape
GE Closing Share Prices
45
40
35
30
25
20
15
10
5
0
Data source: Yahoo! Finance.
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For the exclusive use of C. Luu, 2021.
Page 33
UV7199
Exhibit 22
GE and the Shadow Banking Landscape
GE Capital’s Risk-Weighted Assets and Core Equity Tier 1 (CET1) Ratio
December 31
2015
2014
Estimated risk-weighted assets (billions)
251.1
445.9
14.5%
13.0%
GE Capital Tier 1 common ratio estimate
Data source: General Electric Company annual report, 2015.
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Exhibit 23
GE and the Shadow Banking Landscape
Basel III Capital Requirements
Minimum Capital Requirements
Ratio
% of Risk-Weighted Assets
Common Equity Tier 1 (CET1)
4.5
Additional Tier 1
1.5
Total Tier 1
6.0
Total Tier 2
2.0
Total Capital (Tier 1 + Tier 2)
8.0
Additional Capital Buffers
Buffer
Capital Conservation Buffer (CET1)
% of Risk-Weighted Assets
2.5
Countercyclical Capital Buffer
0.0–2.5
U.S. Global-SIFI Surcharge 1
1.0–4.5
Data source: Unless otherwise noted, data is drawn from Basel Committee on Banking Supervision,
“Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems,” Bank for
International Settlements, December 2010 (rev. June 2011), http://www.bis.org/publ/bcbs189.pdf
(accessed May 19, 2016).
1 Federal Reserve System, “Regulatory Capital Rules: Implementation of Risk-Based Capital Surcharges for Globally Systemically Important Bank
Holding Companies; Final Rule,” Federal Register, August 14, 2015, https://www.gpo.gov/fdsys/pkg/FR-2015-08-14/pdf/2015-18702.pdf (accessed May
19, 2016). Note: the Federal Reserve issued final rules that were more stringent than Basel’s recommended 1.0%–2.5% surcharge for Global SIFIs.
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UV7199
Exhibit 24
GE and the Shadow Banking Landscape
General Electric Q1–Q2 2015 Share Price
29
April 10 
28
27
26
25
24
23
22
Data source: Yahoo! Finance.
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For the exclusive use of C. Luu, 2021.
Page 36
UV7199
Exhibit 25
GE and the Shadow Banking Landscape
GE Capital Dispositions as of December 18, 2015
Assets/Entity
Amount ($ Billions)
Buyer
Synchrony Financial (North American
Retail Finance)
83
IPO
Commercial real estate assets
33
Blackstone Group; Wells Fargo
UK home lending
13.1
Multiple buyers
U.S. Sponsor Finance business and a bank
loan portfolio
12.1
Canada Pension Plan Investment Board
Global fleet services business
10.2
Element Financial Corporation and Arval
Healthcare Financial Services
8.7
Capital One
Transportation Finance
8.2
Bank of Montreal Financial Group
Australia and New Zealand consumer
lending assets
7.5
Various investors
Budapest Bank
3.4
Hungarian government
European Sponsor Finance
2.7
Sumitomo Mitsui Banking Corporation
Corporate aircraft financing portfolio
2.1
Global Jet Capital
Other assets
4.8
Multiple buyers
Total Dispositions
Additional Sale Agreements
Total + Additional Agreements
Target Asset Reduction
188.9
64
252.9
310
Data source: GE Capital, “2015 Resolution Plan: Public Section,” Federal Reserve, https://www.federalreserve.gov/bankinforeg/resolutionplans/ge-capital-1g-20151231.pdf (accessed May 19, 2016).
This document is authorized for use only by Chau Luu in FIN 4438 Bank Management taught by Shen Zhang, Troy University from Feb 2021 to Aug 2021.
For the exclusive use of C. Luu, 2021.
Page 37
UV7199
Exhibit 26
GE and the Shadow Banking Landscape
Nonbank SIFI March 2016 Daily Closing Share Prices
Date
Prudential
72.22
3/31/2016
72.95
3/30/2016
71.52
3/29/2016
72.01
3/28/2016
70.76
3/24/2016
72.83
3/23/2016
74.12
3/22/2016
74.55
3/21/2016
74.94
3/18/2016
73.36
3/17/2016
72.56
3/16/2016
72.42
3/15/2016
73.00
3/14/2016
73.55
3/11/2016
70.56
3/10/2016
70.41
3/9/2016
70.31
3/8/2016
72.13
3/7/2016
71.47
3/4/2016
71.87
3/3/2016
70.76
3/2/2016
70.31
3/1/2016
MetLife
43.94
44.73
42.46
43.00
42.30
43.41
44.09
44.51
44.73
44.08
43.77
43.79
43.90
44.25
42.25
42.00
41.78
42.85
42.33
42.39
42.01
41.68
GE1
31.79
31.83
31.48
31.49
31.11
31.07
31.06
31.09
30.92
30.96
30.17
30.28
30.27
30.34
29.94
30.05
30.06
30.29
30.46
30.22
30.18
29.88
AIG
54.05
54.52
53.39
53.41
52.98
53.44
53.72
53.57
53.71
53.18
52.91
53.02
52.87
52.89
51.54
51.59
51.93
52.66
52.30
52.27
51.83
51.88
Data source: Yahoo! Finance.
1
Note: Although GE Capital was a SIFI, it did not maintain a public share price. The share price of its parent company, GE, is listed instead.
This document is authorized for use only by Chau Luu in FIN 4438 Bank Management taught by Shen Zhang, Troy University from Feb 2021 to Aug 2021.

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