The U.S. and China have begun to concern some economists with record levels of corporate debt. However, when U.S. Federal Reserve Chairman Jerome Powell spoke on the issue during a conference in Florida earlier this week, it wasn’t so much the corporate debt levels that concerned him. It was the way some companies obtain that debt that could lead to problems.
His biggest worry, according to USA Today this week, was that some corporate borrowing is “financed opaquely, outside the banking” system, and that a reliance on shadow banking could “pose a new threat to financial stability.”
Shadow banking emerged largely in the wake of the financial crisis to enable financing when the traditional (and regulated) financial services sector pulled back on lending to limit risk. In the U.S., the Fed estimated in 2013 that shadow banking liabilities had reached $15 trillion. Most recently, regulators have turned their attention to the cryptocurrency shadow banking market.
Not every so-called alternative lender is a shadow lender. Many alternative and marketplace lenders simply offer an online portal through which a consumer or small business can obtain a loan from a traditional financial institution. Others actually partner with those traditional lenders to finance their loans.
What remains is the group of alternative lenders that critics have said charge sky-high rates for risky loans. The Federal Reserve is currently exploring how these players, and the rest of the alternative and online lending market, might be impacting borrowers and the economy at large.
China’s Shadow Banking Crackdown
Chinese authorities have also ramped up their efforts to address the systemic risks that the shadow banking sector poses to the strength of the overall economy. The nation introduced financial system reforms last year that saw regulators’ attention fixed squarely on the shadow banking space. Those efforts saw a sharp drop in stocks that made the nation the worst-performing stock market in 2018, Financial Times reported in April, when shares once again declined on concerns of a revamped war on shadow banking.
Analysts have estimated that China’s shadow banking sector is worth about $10 trillion today. Unlike the U.S., it is actually driven by the commercial banking sector, which keeps shadow assets off balance sheets.
Despite stock market volatility resulting from China’s shadow banking crackdown, the government’s initiatives have, so far, led to a 60 percent decline in banks’ shadow assets, and a decline in corporate debt from 134 percent of total gross domestic product (GDP) in 2017 to 128 percent of GDP in 2018, Natixis data showed, according to South China Morning Post.
“Most of the reduction is due to private corporations’ efforts to divest assets, given the constraints in assessing credit, especially since the clampdown on shadow banking,” said Natixis Chief Economist for Asia-Pacific Alicia Garcia-Herrero in an interview with the publication.
Considering China’s ballooning corporate debt levels, the shadow banking crackdown could continue to be a key tactic among financial regulators in the years ahead.
India Takes Note
More recently, financial regulators in India have taken steps to tackle the nation’s shadow banking sector. Reports last weekend in Bloomberg said economic issues in India are a key focal point in the country’s elections, particularly following a series of defaults by shadow lender Infrastructure Leasing & Financial Services last year.
“There is an imminent crisis in the [non-banking financial companies (NBFC)] sector,” said Corporate Affairs Secretary Injeti Srinivas in an earlier interview with LiveMint. “There is a credit squeeze, over-leveraging, excess concentration [and] massive mismatch between assets and liabilities, coupled with some misadventures by some very large entities, which is a perfect recipe for disaster.”
LiveMint also reported earlier this year that a combined $22 billion is now gone from two dozen shadow lenders, as investors become spooked about government crackdowns and the shadow banking industry’s impact on the broader economy. NBFC “investors are cautious … given near-term uncertainties,” said Citigroup Analyst Manish B. Shukla.