Yesterday, the ADP’s private payroll report indicated a decline of 32,000 jobs. There are ongoing concerns about how reliable these ADP figures are, and, well, the accuracy is always debated. Unfortunately, without government reports due to the shutdown, it puts a damper on reliable economic statistics. If you’ve got thoughts on what to write without official numbers, feel free to reach out.
Shadow Banks II
This week, it was highlighted that in the US, bank lending to non-bank financial companies — often referred to as “Shadow Banks” — is crucial to understanding this year’s loan growth. Currently, Shadow Bank Lending sits at about $1.7 trillion, which represents roughly 13% of overall bank lending.
But how worried should we be about banks lending to these Shadow Banks? When banks extend credit to NDFIs (non-depository financial institutions), they divert from direct lending to consumers or businesses. Instead, they might lend to private equity funds or even provide funds to firms managing credit card receivables, among other things.
This roundabout financing method can lead to a loss of risk, return, and capital for banks. Ideally, when a private credit fund brokers a loan, it assumes that risk. The fund’s investors would face the initial losses, earning profits beyond what’s paid to the bank. But if the risk stays with the bank while profits and capital dissipate, that’s where things get tricky.
Currently, with the boom in NDFI lending, it appears that risk remains within the banking system while returns and capital seep away. This isn’t easy to assess from the outside.
Bank disclosures about NDFI lending are somewhat limited, even though they’re broken down into five categories for regulatory purposes. It’s essential to delve into how these loans have changed over recent times, particularly for banks with significant assets.
These reports often don’t clarify how exposed banks are when lending to NDFIs. For instance, one regional bank has a staggering $62 billion in NDFI loans, amounting to about a fifth of its total loan portfolio. Most of these loans fall under “business” or “private equity,” but understanding their implications isn’t as straightforward as it seems.
Moreover, the interconnected nature of banks and NDFIs complicates things. NDFIs can do many tasks similar to banks but lack the safety nets that banks have, leading them to rely on credit lines — essentially financial lifelines. In tough times, these lines may be tapped, adding risk to banks trying to support their NDFI partners.
The rapid rise in NDFI lending makes it difficult to gauge how much the banking system is truly exposed. As for the potential risks involved, honestly, it’s hard to say if anyone knows for sure.
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