Shadow Banking: The Underground Banking System

Different cultures have different ways of banking. Western culture began the use bank houses early during the Renaissance period, and in some cases before then. This essentially involved a central money-keeper institution that would protect funds as well as lend for a fee. That model is essentially carried forward to today with modern banks and credit unions. However, it is not the only model of banking; traditional western banking simply represents the financial model that governments endorse. There are other methods as well.

Underground banking has long been associated in the West with the laundering of illegal funds to make them appear legal. This involves taking illegitimate funds and investing them into a business or legal entity, making the funds look like revenue. The money then comes out of the business as legal currency that can be used without worry, especially from tax agencies and law enforcement.

However, other forms of underground banking have existed for centuries as well. In Asia, for example, curbside banking has long provided the means for micro-businesses to get started via person-to-person loans. These loans often involve much higher interest charges, but they are also less stringent in terms of application criteria. In a common example, a small merchant goes to a curbside banker for financial assistance. A deal is struck, the amount provided, and the curbside banker then earns profit on the payments coming back. The difference though is there is no government regulation, taxes, or scrutiny. So the curbside banker earns a far greater profit faster.

The curbside banker relies on a couple of factors to be successful. First, the borrowers and the banker are part of a tight community. They don’t just lend to anyone. The borrower and lender are well known to each other in a small social group. The success of the shadow banking system depends on this community supporting the system. Unlike pawn shops, loan sharks or similar, the curbside banker is desired by his customers and protected. That makes the system work.

While the curbside banking model can be quite useful for everyone involved, it’s also very risky. Bankers can be exposed and arrested by disgruntled borrowers who turn on them. Small businesses can be put out of operation by lending rates that quickly get too expensive to pay back. Borrowers can also default, taking off with the funds and there is little recourse aside from illegal activity to get the money back. However, the shadow banking system still works despite the potential problems. And where it does, the profits are huge.

The demand doesn’t often weaken either. There are plenty of people in every culture who need financing but can’t meet traditional borrowing standards or criteria. That doesn’t negate their need; it makes it more desperate. And, unfortunately, it’s starting to catch on in the Western world.

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This article was written by: Christina

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