The Three "Financial Structure" Paradigms Of Modern Finance

Tyler Durden's picture

In a prior post, we discussed the implications of the global shadow banking system having risen to the unprecedented level of roughly 100% of global GDP. By now it should be quite obvious to even the most jaded optimists, that the reason why traditional leverage conduits are no longer applicable (and the only real source of bank credit creation is the Fed via the hopeless blocked up excess reserve pathway), and why credit money (and hence in a Keynesian world "growth") has to come via deposit-free, unregulated "shadow" venues, is that there are no longer enough good money good assets for conventional secured credit creation, and viable levered projected cash flows for conventional unsecured credit creation. Yet not the entire world has gone all in on this gambit, which together with the Fed's money printing, is truly the last bastion of "money' creation. In fact, as the FRB demonstrated, there are three distinct paradigms when it comes to source of credit creation or as it puts it, "financial structure": the US "massive shadow banking system" way, the German "conventional bank deposits funds loan creation" way, and the Saudi Arabian, and soon everyone else, "central planning to the max" way. In a nutshell, these are the three credit system structure extremes, with everything else currently inbetween. These can be visualized as follows:

Follows the FRB's commentary on these three financial system "paradigms"

Three main groups of jurisdictions emerge when analysing the structure of financial systems based on the share of banks, insurance companies and pension funds, other NBFIs/OFIs, public financial institutions and central banks in the total (see Annex 2 and Exhibit 3-1):

  • A first group includes advanced economies characterised by a dominant share of banks combined with a limited share of OFIs that does not exceed 20%. Jurisdictions such as Australia, Canada, France, Germany, Japan, Spain fall in this category.
  • A second group includes economies where the share of OFIs is above 20% of the total financial system and relatively similar, or higher, to that of banks. For instance, the Netherlands, the UK, the US, fall in this category.
  • A third group includes emerging market and developing economies where the share of public financial institutions or the central bank is significant, often on account of high foreign exchange reserves or sovereign wealth funds, and where the share of OFIs is relatively low. This group includes jurisdictions such as Argentina, China, Indonesia, Russia and Saudi Arabia.

The chart above, incidentally, explains much if not all, the tension in modern finance.

On one hand, Germany and some of the other more stable financial systems in the world such as Canada, have traditionally relied on deposits (a bank liability) to fund bank assets (loans, secured mostly and to a less extent unsecured), represented in this case by the Green line (traditional banks) being so far higher than the Red line (Shadow banks). This system had a direct linearity between cause (deposit dollar) and effect (loan dollar), magnified simply by the legacy structures of fractional reserve banking.

It is this chart which explains why Germany is so scared of hyperinflation: should the massive "deposit" liability tranche of its banks start to withdraw over fears of rising price, and start chasing hard assets, not only would this start an epic bank run, not only will banks be promptly undercapitalized (recall that Deutsche's Bank's Tangible Capital is in the ~2% neighborhood, meaning the bank can withstand just 2% of deposits flowing out due to an inflation risk scare or otherwise, before it has to start selling assets to keep its equity buffer in place).

Ironically, it is the fact that Germany played along the rules of the conventional game that has put it in the current predicament: had Germany followed in the footsteps of many others, such as the US, and had "Other Financial Institutions" (OFIs) represent the bulk of assets, the Bundesbank and German politicians could care one bit what the ECB does to spark inflation fears. After all shadow banking is deposit free, and there is no fear of deposit outflows leading to an undercapitalized position. Sadly, that is the price to pay for preserving some semblance of a traditional banking system.

Which takes us to the US (and UK and Holland) three jurisdictions, where Shadow Banks (or OFIs) represent the bulk of assets. It is here that deposit levels are largely irrelevant as the financial system has over the past 2 decades primarily used shadow liabilities as funding conduits, which in turn means that central planning authorities have far greater degrees of freedom to intervene and monetize assets in the system, to preserve overall systemic leverage. It is also this tension between non-German Europe (willing to load up with Shadow liabilities) and Germany (not quite so willing), that has defined the European crisis for the past 3 years. It also implies that going forward central bank intervention will be determined to a big extent how dominant the Banking Sector is, whether Shadow Banking liabilities are rising (non-German Europe mostly) or falling (the US), and the relative position of central banks within the financial sector).

Which finally takes us to the third paradigm, that os Saudi Arabia, and China, and Russia, and Argentina, and Indonesia, and Switzerland and slowly but surely virtually every other place in the world, as the coordinated central bank cartel becomes the one and only source of money. And not just any money, but the definition of "Gresham Law" money, as creeping central planning and ubiquitous monetization, means very soon only central banks will be the source of any incremental leverage, while all "good credit" is slowly but surely driven out of the system (courtesy of perpa-ZIRP and fears of what happens when central banks finally lose control).

It is this third paradigm that is the preamble to the final collapse, because just before the endgame, it will be every central bank against everyone else, and against itself, whereby the only way to get ahead is to destroy your own currency of exchange as fast as possible, at first on a relative basis, by devaluing against all other currencies in a closed loop, then on an absolute, by devaluing against hard assets (see Executive Order 6102 and PM confiscations/redenominations).

It is this endspiel that the entire developed world is rapidly rushing toward. And it is this endspiel that only the hopelessly clueless central bankers and Economist PhDs that are responsible for bringing the world to the edge of collapse, are confident can be safely navigated. Everyone else is quietly tiptoeing toward the exits...

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holdbuysell's picture

"Everyone else is quietly tiptoeing toward the exits..."

That sounds about right.

GetZeeGold's picture



When a plane hits the building move towards the exit....when two planes like hell.


prains's picture

i thought there was only one economic system but under many different names, the system being who controls the price/supply of energy (oil) to make the machines go round and round

Errol's picture

Prains, you are writing about one of the forms of tangible wealth; this pair of articles is discussing the abstract gambling chips referred to as money.

Those fortunate fellows who have the exclusive concession to create more gambling chips at virtually no cost to themselves most sincerely hope that you will continue to accept the latter in exchange for the former.

prains's picture

I agree, what i was refering too was an economy of which money is only one part and discussions of only one aspect of an economy is much like discussing one particular tree in a forest when really its the forest in total which needs more discussion. Trying to pin point one aspect of a failing empire IMHO is erroneous as only working on biceps in a gym and no other body part makes for a gork. There is a symbiosis of parts which make up the body of failure that is the american economic system. This is far more important an issue than this article illustrates.

Whoa Dammit's picture

I thought the three financial structure paradigms of modern finance were:


Steal Some More

Never Get Indicted

awakening's picture


Buy politicians and judges

Never go to prison (see #2 for how).

Real Estate Geek's picture

Would the US's chart look substantially different if the CB's gold was marked to market, instead of the current book value?

RiverRoad's picture

Blow up your currency; blow up your debts in that currency too.  Convenient.

neutrinoman's picture

The US used to be in the deposit-dominated category, before the 90s. Some people, like Volcker, want to go back to this. But the third paradigm is currently ascendant.

There's a big difference with the US, though: the main US export is dollars, not commodities, say.

zorba THE GREEK's picture

IMHO the best thing any country could do under the present circumstances would be 

to strengthen their currencies by trying to balance their budgets. That way when TSHTF

they would be able to weather the storm and import energy and goods at a discount.

Clowns on Acid's picture

"Everyone else is quietly tiptoeing toward the exits...".....Umm...where are they going? Will Western CB's confiscate or cap gold? Should one hold cash for the deflationary hit, then buy farmland, pm's, lead?

What is on the other side of the "exits" ?   

new game's picture

no matter how you plan, there will be a majority that have no plan.  your plan better take this into acount or you don't have a plan.

these pirates use many tactics both legal and illegal- either way and no mater how the future unfolds a strong defense will be your best offense...

location is the key...

supermaxedout's picture

Good article because it lays out what are the fundamental controversies between the Anglo Saxon banking system and Euroland which has a saving culture serving as the base for loans.

The crucial point is indeed inflation. The US want inflation, lots, lots of inflation while the mayority of Euroland, China, Russia, India etc do no like it.

The US did already a lot to create massive inflation and made it clear that they are willing to run havoc and might let the Doillar go kaputt. This is the threat of the US: Accept a high inflation so that the US Dollar system can continue or we let the Dollar go kaputt with all the devastating consequnces for the world economy. We will pull all the other economies down together with us.

The point is, till now the US was not able to create massise inflation, despite their efforts.  Food prices are high but not that high, despite the fact that the US is using enormous amounts of food for the production of bio-diesel etc. (reason is, that food production in other parts of the world is expanding using the US industrial style technology)  Its the same old gme of these bastards.  In the 1930 they used in the US grain and corn to fire locomotives just to keep the price of food high, while all around the world there was a hunger period. But this time the situation is different.

Oil prices are high but not that high. The US managed to decouple Brent from WTI pices but no results. China gets lots of oil from Iran and Russia paying in Renmimbi. Again no real inflation created via the oil price. Damn !  China is establishing its own global financial system thus a collapse of the Dollar system would be bearable for them. Damn!

Now there is really an endgame. The US has to make the choice whether to kill the Dollar (which might be a good choice because the Dolar is already on his deadbed and we all know, better an end with suffering compared to a suffereing without an end).  Or to try to make in coperation th best out of this mess. No doubt nobody wants that the Dollar is going suddenly bust because it would cause extreme damage. But this might be the outcome if the US is not realizing that on one side they are the number 1 military force in this wolrd but economically they have not passed the exam. The have cheated and betrayed and dont want to play by the rules (except their owns) and only their weapons do protect them till now from the harsh consequences of their economic downfall. But this can not go on for ever.

Even a war can not help the USA anymore. They have already exploited their own population via their fraudulent  financial system to finance the ongoing wars all over the world.    But a real, big war might create at the end a level playing field. All countries destroyed then the US is not alone with its defeat.  One could get such an impression slowly when observing the doings of the US during the past 12 years. Hopefully I'm wrong in this.


supermaxedout's picture

Nothing would replace the Dollar. Everything would be different.  The Dollar was or is a unique phenomen and only possible because the US were the only important country or state which made it through WWI and WWII without damages. All others lost territories or influence, or population or infrastructure was destroyed. They were all down on their knees and in debt against the US.

The US was the shining winner. It dominated the world economically and huge parts of the world by its military.  Such a situation is never to occur again. The next big war knows only loosers.

If there is no war, then the important nations have to compromise. By no doubt America stays very important but most probably equal to China, Russia and on the long run also India. Economocal also Euroland can play a role. In case Euroland does really get its act together and there is one day a USE with France providing nuclear weapons then Euroland is also going to have a say. Besides That there is Brasil, Iran and other which do have also ambitions to play a greater role in the world.

Money is the base for international exchange. Money what is recognized in value by all participants and a kind of money which is not giving unfair advantages to one nation (as it is now with the Dollar). There a only two possibilities:

a) All do agree in consensus on a new world currency which is fulfilling these prerequisites. This is far in the future and not to see in the moment. But no doubt one day this is going to be the case.

b) Now there is a only one money which has an intrinsic value making it suitable as a worlds money. This is gold. And this is coming. If that would be not in the cards, then the Central Banks of this world would not have it in store. Its the money that gets value by its scarcity. And this scarcity is produced by the holdings of gold in the central banks (which are increasing).  Its the only real value central banks have because gold is the number one precious metall beloved by mankind for its beauty. Its stupid thats true but mankind is very stupid and gold is simply a tool the idiots of this world can all agree on.    Gold is going to be the base and the paper or virtual currencies of the future have to accept that they are only derivatives of real money. Gold is for international finance and trade the same as the "original meter" stored in Paris for the technical world. 



larz's picture

Count me in NR

JenkinsLane's picture

Another great article, thank you.