SHADOW BANKING: THE FUTURE OF BANKING?
As banks find their margins squeezed on traditional lending and payments activities, nonbank credit and financing—supported by technological innovation—is growing exponentially.
Worldwide, peer-to-peer lending is growing, and credit is expanding outside the realm of regulated banks.
In the UK the sector is attracting institutional investors. “As a result the growth rate in the UK is outpacing the rest of Europe, You can see it: The London metro is full of advertising for peer-to-peer lenders.”
The CCAF study, co-authored with EY and 14 leading industry associations, showed not only the rapidity of growth of shadow banking in Europe but also the way that growth is shaped by cultural differences between countries. “The Netherlands and Spain have relative and absolute bases of strong growth in rewards-based crowdfunding, which has a philanthropic dimension to the investment decisions,” The study—based on 255 leading platforms in Europe—is believed to capture 85% to 90% of the European online alternative finance market.
Several factors are driving growth in these new forms of finance, low interest rates—which are pushing investors to seek better returns—as well as the “significant loss of trust in financial institutions.”
“But our view at the Centre it is that yes, all of this has possibly accelerated the development, but there is a more fundamental trend going on beneath all of this, and it is a technology-driven trend. At the end of the day technology is the big enabler. And what does technology enable? At a very basic level it helps match providers of funding with users of funding. It enables the disintermediation of incumbent institutions—and this is only the beginning.”
“What happened,” says Laura Kodres, chief of the Global Financial Stability Division at the International Monetary Fund, “is that other types of shadow banking expanded—in particular, the use of investment funds that are now supplying credit to small enterprises, leveraged loans [loans to companies or individuals that already have high debt levels], and project finance.”
For example, the nonbank share of leveraged loans as a percentage of all leveraged loans in the US has grown from about 20% to 80%, she says. “A lot of that credit activity is now taking place outside of banks, for instance among credit-focused mutual funds.”
Regulation imposed on banking after the financial crisis, such as capital constraints from Basel III regulations, are setting limits on the activity of traditional banks and spurring other forms of credit. “Lending is actually a more expensive activity for the traditional commercial banks, and nonbanks see this as an opportunity to be able to provide credit at lower cost, in part because they do not have to follow the same capital requirements and they do not have to follow the same liquidity requirements that traditional banks do”
“In the Chinese case most of the shadow banking is taking place in the form of trust companies, which are financing specific projects of property companies, energy firms or manufacturers,” Chwang says. Once securitized, these products are sold to high-net-worth individuals.
A cap to interest rates paid on Chinese deposits to investors “is really why the wealth management products in China in the shadow banking system have grown up until today, Interest rates in China are regulated by the government, and that has created an opportunity for wealth management products to offer…much higher rates of returns.” Chinese officials have said that they will deregulate interest rates paid on deposits in the future, which should help traditional banking channels. “Shadow banking in China will become smaller than it is today.”