When we talk about shadow banking, we think of China, one of the world’s most indebted nations. Lending by companies that do not own a banking license has reached 50 trillion yuan ($7.3 trillion), or about 42 percent of gross domestic product, according to Moody’s Investors Service.
As the recent banking crisis is forcing investors to figure out where the next pressure point might be, they are starting to see that the US has quietly built up a huge pile of hidden debt as well. After a decade of a risk-on run, the US leveraged finance market — almost held entirely by shadow lenders which typically operate with little or no regulator oversight — has topped $3 trillion. Money managers are worried, and even the slow-moving government has signaled closer scrutiny.
At first glance, it’s perhaps good news that banks have become less exposed to corporate America. Since the global financial crisis, corporate borrowing has shifted away from the traditional lenders — which are subject to stricter regulations — towards institutional and retail clients. Banks’ market share has fallen from more than 50 percent at the turn of the century to just 37 percent in 2021, according to Moody’s.
This is especially the case in the $1.3 trillion leveraged loan market, which caters to riskier companies and private equity’s buyout activities. Banks still arrange many of these loans, provide information to investors and put together a group of buyers. However, they often don’t end up holding the debt — or at least try not to.
But the recent demise of SVB Financial Group is raising questions of how much lending banks have given to shadow financiers. Consider, the largest portion of Silicon Valley Bank’s $74 billion loan book consisted of so-called subscription lines given to private equity, a typical nonbank lender. This kind of credit is especially useful when money is tight — they give private funds the flexibility to complete deals without having to go to their investors each time they need cash. But they are also hard to offload, in part because they are not assessed by major credit ratings agencies.
There are other exposures. Fund managers routinely use temporary lines of credit from banks, or warehouse lines, to pay for leveraged loans before packaging them into bonds known as collateralized loan obligations. Products such as CLOs and other asset-backed securities are now the largest non-bank source of corporate loans, commanding a 29 percent market share as of the end of 2021. Meanwhile, private equity also tap their Wall Street bankers for net-asset-value loans during periods of market upheaval, often times to shore up their portfolio companies. But since there is limited public disclosure, we do not have a clear sense of how much exposure banks have, and whether we should be worried about spillovers. We can only speculate.
Further, China’s shadow banking has been on a decline since the government’s deleveraging campaign began in earnest late 2017. This is in sharp contrast to the US, which is seeing a rising trend.
To be sure, I do not see shadow banking as something negative and shady as its name seems to suggest. Often times, nonbanks, such as hedge funds and private equity, provide much needed financing to companies shunned by traditional lenders.
Consider China’s 18.9 trillion yuan trust sector. They were the early-stage financiers that helped real estate developers launch new projects before banks were willing to give out construction loans. Crackdowns aside, Beijing should also thank these lenders for helping to modernize China. In just two decades, the country’s urbanization rate jumped by over 20 percentage points to about 65 percent.
Nonetheless, while shadow banking often serves a key purpose, it is important that regulators know the contagion risk they pose, and whether they might create chaos in the broader financial sector. In this sense, the US’s known unknown is even worse than China’s scary debt pile.
Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. Views are personal, and do not represent the stand of this publication.
Credit: Bloomberg
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