Subject: Shadow banking risks
I asked Gemini: How deeply involved with shadow banking are the regulated banks? Could a shadow banking failure in 2026 pull down the financial system the way the Lehman and AIG failure did in 2008?

Gemini provided a long, detailed explanation. Here’s the summary.


Regulated banks are more deeply intertwined with “shadow banking” — now formally called Non-Bank Financial Intermediation (NBFI) — than they were in 2008, but the nature of that involvement has shifted from owning the risks to financing the entities that take them.

As of early 2026, the global shadow banking system is estimated to manage approximately $238.8 trillion in assets, accounting for nearly half of all global financial assets.

When economists refer to “total global financial assets,” they are describing the combined value of everything that represents a financial claim on future cash flows. As of 2026, this total is roughly $486 trillion.
The Global Financial “Pie” (2026 Estimates)

The Financial Stability Board (FSB) generally breaks these assets into three main buckets:

1. Central Banks & Public Institutions (~10-12%)

This includes the reserves held by the Federal Reserve, the European Central Bank, and others. While technically assets, they are the “ballast” of the system.

2. Regulated Banks (~38-40%)

These are the traditional “bricks and mortar” or major investment banks (JP Morgan, HSBC, etc.) that take deposits and are subject to strict Basel III capital requirements.

3. Non-Bank Financial Intermediation (NBFI / Shadow Banking) (~48-50%)

This is the largest bucket, totaling approximately $238.8 trillion. It is divided into two categories:

The Broad Measure: This includes the Stock Market (public equities), Insurance companies, and Pension funds. These are “non-banks,” but they are largely transparent and regulated.

The Narrow Measure: This is the “true” shadow banking—private credit funds, hedge funds, money market funds, and “special purpose vehicles.” These entities do “bank-like” things (lending and borrowing) but without the same safety nets or transparency.

Summary Comparison
Feature 	         2008 (Lehman/AIG) 	                         2026 (Shadow System)
Origin of Risk 	         Subprime mortgages inside banks. 	        Leveraged corporate loans in private funds.
Interconnection 	 Banks lending to each other (interbank). 	Banks lending to “shadow” funds.
Transparency 	         Low (Complex derivatives). 	                Very Low (Private contracts/No public filings).
Regulator View 	         Blind to off-balance-sheet SIVs. 	        Watching banks, but blind to the funds.

The Bottom Line: A shadow banking failure in 2026 is unlikely to cause an overnight “black hole” like Lehman did because the risk is more dispersed. However, it could trigger a prolonged credit freeze where regulated banks, fearing for their capital, stop lending entirely, causing a deep and painful economic recession. [end Gemini quote]

Federal Reserve Chair Jerome Powell’s term will end in two weeks. The Senate recently held confirmation hearings with Kevin Warsh to replace Jerome Powell.

Kevin Warsh’s philosophy of the Fed’s role is quite critical of the past 25 years. Warsh believes that the Fed’s bailouts and “put” with the financial system has caused moral hazard and excess risk-taking at taxpayer expense. He views the Fed’s primary job as maintaining price stability (inflation control) rather than ensuring the survival of private investment funds.

A whole generation of speculators has grown up with no experience of market discipline without a Fed safety net. Shadow banks are increasingly making “covenant lite” loans – without covenants limiting the debts of the borrower – with the assumption that they can always roll over the debts at low interest rates when they come due.

A growing number of private companies are using PIK (Payment-In-Kind) toggles. Instead of paying their bondholders in cash, they are "paying" by issuing more debt. Many companies are borrowing in order to make stock buybacks. Many are zombies that are paying only interest but no collateral. When a debt comes due they borrow more to pay it. What will happen when interest rates rise and the rubber meets the road? Without bailouts it won't be pretty.

Kevin Warsh does not believe that the Fed exists to bail out the markets.

Imagine the shock when that’s not true anymore.

Kevin Warsh wants the Fed to “stay in its lane.” That means controlling inflation and stopping a financial crisis by providing liquidity to regulated banks (not shadow banks) with 100% safe collateral (Treasuries), not to shadow banks with opaque-valued dodgy collateral (e.g. real estate).

Paul Volcker was willing to cause the nasty 1980-82 recession to break the back of inflation. (I remember it well.)

Will Kevin Warsh be willing to risk a stock and bond market meltdown by sticking to his guns and allowing interconnected shadow banks (and pension funds and insurance companies and probably some regulated banks who loaned money to the shadow banks) to fail?

There’s a real potential for that demolition derby.

Wendy