Non-bank lending, AKA shadow banks, AKA “huhhhhh?” have seen their assets grow to $52T, potentially posing a major threat to the financial system.
According to CNBC, the US sits firmly atop the sector with $15T in assets — though its share of the global market has fallen as China has grown its assets to $8T.
They look like banks, they lend like banks…
But they’re not banks. “Shadow banks,” which include hedge funds and private equity firms, face fewer regulations than traditional banks, allowing them to make riskier investments, including lending to underqualified borrowers.
Even art dealers like Sotheby’s have become shadow banks — making millions of dollars’ worth of loans to trust-fund babies who want to buy masterpieces.
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Why it matters
The sheer magnitude of underregulated lending is cause for concern, as history shows it can decimate the financial system.
Shadow banking played a major role in tanking the global economy (ever heard of the 2008 financial crisis?). Beyond traditional bank bailouts, the government also had to shovel trillions of dollars into non-bank lenders to support those systems.
What are the specific dangers?
Credit rating agency DBRS identified 3 risks that shadow banks pose in times of market duress:
- Lack of structure: Shadow banks lack resources to deal with periods of low liquidity and heavy withdrawals (traditional banks have deposit insurance).
- Lack of experience: What kind of pilot do you want behind the wheel of the money plane during a crash landing?
- No earnings diversification: If a market deteriorates, shadow banks usually don’t have anything to fall back on.
On the other hand…
Advocates believe shadow banking provides buffers against market stress, which may be true, DBRS says.
But, as history has shown, the potential fallout of shadow banking during an economic downturn poses a much larger downside than the buffers it supposedly provides when markets are peachy keen.