SHADOW BANKS COME INTO LIGHT IN GLOBAL LENDING / THE WALL STREET JOURNAL

Shadow Banks Come Into the Light in Global Lending

Nonbank financial institutions have a growing presence in cross-border credit, but we won’t know the real effect until a downturn arrives

By Mike Bird




In cross-border credit, regular banks are out, and shadow banks are in. Our limited knowledge about how the latter will behave in a downturn is a reason for concern.

According to Bank for International Settlements data released this week, nonbank financial institutions are leading the growth in cross-border lending, with cross-border banking claims in the third quarter up 17% from a year earlier. That’s the fastest growth in at least six years, when records began.

Banks’ cross-border claims on and liabilities to nonbank financiers have risen by nearly $8 trillion since the end of 2013, while their cross-border exposure to other banks has actually declined slightly under the weight of increasingly stringent regulation.

Shadow banks, which include brokers, clearinghouses, funds, investment trusts and structured finance vehicles, get a bad rap from the unfortunate name. And the Financial Stability Board’s attempt to rebrand them as “nonbank financial intermediaries”—snappy!—hasn’t taken off.

Nothing is inherently wrong about their becoming more important. But the shift raises questions about how they’ll behave in a sharp slowdown or financial crisis.

The rise of shadow banking since the 2008 crisis is a lesson in being careful what you wish for.

Research last year from the Barcelona Graduate School of Economics suggested that raising bank capital requirements spurred activity by nonbank lenders—unsurprisingly. It also determined that some nonbank lenders made that crisis worse because they lacked stable funding sources.

Nonbank financiers also tend to be less well hedged against international risks than banks, according to International Monetary Fund research published last year. That contributes to higher volatility in capital flows as funds’ risk appetites swell and shrink.

That’s not the whole story, of course. Nonbank financing has been made safer in recent years.

The complex structured vehicles that characterized the sector before the financial crisis are a far smaller presence. Reforms have made money-market funds more stable.

Ultimately, investors won’t know what effect the growth of the sector has had until a downturn arrives. Then the sector’s big cross-border presence might end up being an important—and underappreciated—factor in how the drama unfolds.