What is a Shadow Market?

A shadow market includes any unregulated private market in which individuals or entities can purchase assets or property that are not publicly traded. The purpose of a shadow market is to shield participants from the oversight and transparency of conventional marketplaces which often include significant documentation. Because activity and transactions on a shadow market have little or no oversight, it offers participants the opportunity for strategies or schemes otherwise unavailable in public markets.

Key Takeaways

  • A shadow market is an unregulated (or less regulated) private market where goods and services are exchanged.
  • A shadow market could be as simple as a handshake transaction between friends, or it could be as big as the multi-billion dollar alternative lender market.
  • The shadow market is not to be confused with the black market for illegal goods (or legal goods being sold illegally).

Understanding the Shadow Market

A shadow market may describe a simple transaction between two individuals, such as one party agreeing to purchase an asset without the burden of standard methods. Or a shadow market can much larger, such a private mortgage lender who doesn't qualify or fall under the regulations of a bank but supplies people with credit across the country anyway. A significant number of companies fall into this category.

The expression "shadow market" makes people tend to think of illegal or otherwise shady business arrangements, but not all shadow markets are nefarious in nature. A robust shadow banking system of non-bank financial intermediaries provides similar services to traditional banks but with the added benefit of convenience and often less paperwork. Such institutions include payday loan companies, private mortgage or loan lenders, hedge funds, insurance companies, and private equity funds. Many financiers in this space take issue with the expression "shadow banking," as if they're back alley loan sharks. Although, the shadow market for mortgages did play a primary role leading up to the subprime mortgage crisis of 2007 to 2008 and the global recession that followed.

When times are good, these types of legal shadow markets or systems generally operate without much scrutiny. When the economy tanks, they're a usual suspect. This often leads to certain types of businesses having to deal with more regulation or increased oversight.

There is also the black market. This is the market for illegal goods, and goods and services that should be taxed but on the black market the transactions go unreported. In this way, there is a black work market for undocumented work and pay under the table, as well a black market for illegal drugs and also legal drugs that are being bought or sold illegally.

Example of Real World Shadow Market

Traditionally, if you wanted a loan you went to the bank, or possibly facilitated a loan agreement with family or friends. In recent years, technology has allowed for the rapid expansion of this latter form of lending: lending between peers.

Online peer-to-peer lending platforms allow people with money to connect with someone needing money. The platform handles the exchange and repayment of funds, with the platform taking a small cut for themselves.

In the banking system, all these loans are tracked for reserve requirement purposes. Since peer-to-peer lenders fall outside the banking system, there is less regulatory oversight and size of the market largely unknown. The size of the market can be estimated based on the advertised numbers of peer-to-peer lending firms. Or in some cases, these firms are publicly traded and therefore their accounting records show the types of business volumes they are doing.

The estimated global peer-to-peer lending market was $26 billion in 2015 and is expected to grow to $898 billion by 2024.