Traditional lenders in the past have accounted for a significant percentage of corporate and personal lending. That is now changing as less traditional monetary sources are providing loans at an ever-increasing rate. This is more commonly referred to as the shadow banking system.
The reason why shadow banking is a concern is that there is less regulatory scrutiny on the business practices of non-traditional lenders. Because there is less scrutiny, there’s potential for more risk. We saw during the 2008 market meltdown how vulnerable traditional banks were to financial uncertainty. It’s hard to quantify the type of embedded risk contained within the financial system from shadow banking activities. That unknown is a little scary.
A great article by Jeff Cox on CNBC.com highlighted the challenges the regulators are facing as they confront the growth of non-traditional lending. An excerpt is provided below.
Nonbank lending, an industry that played a central role in the financial crisis, has been expanding rapidly and is still posing risks should credit conditions deteriorate.
Often called “shadow banking” — a term the industry does not embrace — these institutions helped fuel the crisis by providing lending to underqualified borrowers and by financing some of the exotic investment instruments that collapsed when subprime mortgages fell apart.
The companies face less regulation than traditional banks and thus have been associated with higher levels of risk.
In the years since the crisis, global shadow banks have seen their assets grow to $52 trillion, a 75% jump from the level in 2010, the year after the crisis ended. The asset level is through 2017, according to bond ratings agency DBRS, citing data from the Financial Stability Board.
Source: April 11, 2019 CNBC.com article by Jeff Cox
So, why does this matter? Shadow banking troubles would have a ripple effect throughout the entire economy. One can imagine what might happen to the overall economy if unregulated lending encounters serious headwinds. This is a problem that needs to be monitored.
There’s a reason why we are cautious as we invest in financial services companies. This caution is why we limit the amount of exposure in any given financial services asset. We are fully aware of the potential risk to financial services companies if a downturn in the economy occurs. This systemic risk is one we monitor on an ongoing basis and is a factor as we make investment judgments.
The lack of transparency related to the shadow banking system is troubling, but we do our best to decipher what risk and return factors exist. We will continue to monitor conditions and adjust as needed based on our ongoing research.
If you have any questions about this information, please let us know. Always here to help.