One view of the financial crisis of 2007-2008 is that it was not centered in traditional banking. The term shadow banking " ... refers to credit intermediation involving leverage and maturity transformation that is partly or wholly outside the traditional banking system." That is, shadow banking substitutes at least partially for simple banking in the creation and funding of debt. Several components of the shadow banking system contributed to the breadth of the financial turmoil that began in 2007, and the magnitude of the financial panic in September 2008, according to the Financial Crisis Inquiry Commission (FCIC). In response, regulatory policymakers have been analyzing how the shadow banking system works, and considering options to promote greater financial stability in shadow banking. Congress is considering several shadow banking regulatory reform proposals (e.g. changing the status of repurchase agreements [repos] in bankruptcy proceedings), overseeing related agency rulemaking (e.g., regulations for Money Market Funds [MMFs]), and overseeing the implementation of related financial reform legislation (e.g. applying the capital requirements in Section 171 of the Dodd-Frank Act to nonbanks). This report develops a general framework for analyzing financial intermediation, and applies these concepts to several specific shadow banking sectors. The report focuses on comparing and contrasting the fundamental economic problems of simple banking (which will be referred to as luminated banking ) and associated policy responses to analogous problems and policy proposals in shadow banking. Shadow banking provides a similar general service (financial intermediation) as luminated banking, and is subject to similar fundamental economic problems. Furthermore, many of the proposed regulatory responses for shadow banking have policy trade-offs analogous to regulatory policies in banking, and some shadow banking sectors already have a financial regulatory regime (such as securities regulations). Many of these economic problems and potential policy responses are illustrated by the experiences of five shadow banking sectors (repos, nonbanks, asset backed commercial paper [ABCP], securitization, and MMFs) during 2007-2008, and by regulatory responses currently being considered. Similarities and differences between securities market regulation and banking regulation can influence the size and stability of the financial system. In many cases (but not all), the kind of regulation applied to securities market activities is fundamentally different from the regulation of chartered depository banks. Banking regulation is typically applied only to specific institutions, is risk-based, takes into account the linkages between banks through the payment system, and includes government emergency backstops, such as a lender of last resort and a deposit guarantor. Securities regulation, which several categories of shadow banking involves, generally requires disclosure of material risks, but typically does not limit the risk that sophisticated securities market participants may take. On the other hand, the regulation of securities is often product and activity based, and therefore may adapt to financial innovations in which debt-related securities are offered by new kinds of business entities. Differences in these regulatory regimes can affect the degree to which debt is created through banking or shadow banking. The diversity of shadow banking activities and institutions makes it difficult to generalize; however, the degree to which debt financing in the financial system is covered by risk-based regulation, has access to emergency backstops, or can easily adapt to innovation in the provision of similar services may be influenced by regulatory choices for banking and shadow banking. By extension, changes to the regulation of shadow banking can affect the relative stability of the overall financial system. The organization of the report is as follows. The report defines luminated banking and shadow banking, and identifies several common sources of financial instability from an economic perspective. The report describes some of the standard economic tools (including regulations and emergency support) that are often applied to banking. It then describes five major components of shadow banking, and for each one, recounts its experience during the financial turmoil of 2007-2008 and analyzes policy proposals to change the regulatory approach and emergency support for that sector. The policy proposals are related back to analogous policy proposals in banking regulation. Defining "shadow banking" is difficult because defining banking is difficult. Some analysts might be tempted to define banking as whatever firms with bank charters do; however, policy discussions of shadow banking include activities in which chartered banks participate, sometimes only with each other. Therefore, a definition that is based on functions may be more useful for policy analysis, but even the functional definitions offered by various researchers have varied significantly, with important implications for what gets included under the label "shadow banking." This report will follow a functional definition, seeking to provide a framework for analyzing several large sectors of the financial system that are usually included under the rubric "shadow banking," yet excludes insured deposits of chartered banks that hold their loans. In broad terms, both banking and shadow banking provide the same service, which is financial intermediation. Financial intermediation includes gathering funds from savers, screening and qualifying applicants for funds, issuing and holding financial assets, and coordinating the payment of returns to savers. Shadow banking involves providing this financial intermediation with at least one difference from simple banking. In many cases (but not all), that difference involves reliance on securities markets to fund loans. If shadow banking has at least one difference from simple banking, what is simple banking? Simple banking, or luminated banking, has each of the following four elements. The first row of Figure 1 illustrates the flow of funds connecting savers and borrowers in a luminated banking business model. Luminated banks 1. gather funds in the form of deposits (time and transaction) 2. have special business charters identifying them as depositories 3. offer loans (and screen applicants) 4. hold the loans they originate. Repayments of loans fund the interest for depositors. The term shadow banking has been used to describe a variety of firms and activities that have little in common. However, they each differ in an at least one respect from the simple conception of banking illustrated in the first row of Figure 1 . In this illustration, the term luminated banking is being used to describe a simple form of the "originate-to-hold" model of depository banking. In Figure 1 , each following row provides an illustrative example of an activity or firm that deviates from luminated banking in at least one respect, yet provides similar financial intermediation. Adjusting the focal point of intermediation from left to right, the first shadow banking example in Figure 1 illustrates a substitute for deposits (in this case repos), the second shadow banking example illustrates a substitute for firms with special bank charters (non-bank intermediaries), and the third row illustrates a substitute for holding loans (in this case selling loans through securitization). The following five examples are a non-exhaustive list of shadow banking sectors. This list is included because each of these sectors will be addressed more fully in the policy analysis section of the report. They are presented here to see how each fits into the general concept of financial intermediation and how each differs from, or can be incorporated in, simple banking. (A) The Repo Market—Rather than gathering funds from depositors, some chartered banks (and nonbanks) borrow through repurchase agreements (repos, discussed more fully below). In a repo, a firm sells a security today with a promise to repurchase the security at a later date for a specified price. The time span and price differences are analogous to a loan and interest. Repos differ from simple banking in the way in which intermediaries gather funds from savers. Financial firms that fund themselves with repos may or may not have bank charters, may or may not extend credit or purchase debt, and may or may not hold the loans they originate. However, the first row of Figure 1 shows that if a chartered bank borrows through repo markets (rather than deposits) in order to fund its lending activity, the financial intermediation is very similar to luminated banking. Furthermore, firms without bank charters can also gather funds from savers through repos. (B) Firms without bank charters—A firm does not have to be a chartered bank in order to borrow or lend, and luminated banking involves borrowing from depositors in order to offer and hold loans. In a trivial, but highly illustrative example, there was an ice cream shop in Pennsylvania that accepted deposits and offered loans. Trusts and non-depository investment banks are more common than ice cream shops that offer banking services. The second row of Figure 1 shows that if a firm without a bank charter funds itself with deposit-like loans while at the same time extending credit or purchasing debt, the resulting financial intermediation is very similar to luminated banking. (C) Commercial Paper—Firms do not have to go to banks to in order to borrow. Debt can be issued and traded through securities markets. Rather than originate and hold individual loans, chartered banks (and nonbanks) have at times sponsored interests in commercial paper, which is an example of marketable debt. One common form is to issue asset-backed commercial paper (ABCP), in which the commercial loans serve as collateral for shorter term debt issued in securities markets. Although not depicted in Figure 1 , ABCP represents relatively short term borrowing (on the deposit side of financial intermediation) that is used to acquire and fund generally longer-term commercial debt. Commercial paper is not funded by deposits, and can be sponsored by a non-bank, and can involve acquiring commercial loans rather than originating commercial loans, yet the organization of the financial flows are similar to luminated banking. That is, savers extend short term loans to intermediaries, which hold commercial debt. (D) Securitization—Banks (and nonbanks) do not have to hold the loans that they originate. They can sell the loans to other banks (or nonbanks). If the loans are then funded by issuing securities, typically passing through the loan repayments, it is said to be securitization. The third row in Figure 1 illustrates securitization by a bank.