The other side of the coin is an explosion of lending by bond funds and other investment vehicles that are often collectively referred to as “shadow banks.”
Banks are now much less important for providing credit than they used to be because there is a set of operations and financial intermediaries that provide credit throughout the global financial system in an “informal” way.
The expression serves to categorize the group of intermediary companies in the financial segment that do not participate in the traditional banking system. In other words, they are “in the shadow” of the system, which is why they are called shadow banks.
It is common knowledge that financial technologies such as securitization make it easier for markets to lend more and that more onerous regulations make traditional lending much more complicated for banks. Meanwhile, people are putting more and more money into investment funds instead of bank accounts, reveals a study by the National Bureau of Economic Research, which focuses on the North American market.
“The traditional model of bank-led financial intermediation, in which banks receive deposits from savers and make information-sensitive loans to borrowers, has seen a dramatic decline since the 1970s. Instead, private credit is increasingly more intermediated through independent transactions, such as securitization”, says the new NBER (National Bureau of Economic Research) study.
Increasingly, “the heavy lifting” of the financial system is now being done by capital markets. At least in the USA.
The Financial Times in an article based on the new NBER (National Bureau of Economic Research) study estimates that the market share of US banks in all private loans has almost halved, from 60% in 1970 to 35% last year ; loans as a percentage of bank assets fell from 70% to 55%; and the percentage of household wealth held in deposit accounts fell from 22% to 13%.
The other side of the coin is an explosion of lending by bond funds and other investment vehicles that are often collectively referred to as “shadow banks.”
Although debt securities insensitive to regulatory information – debt securities – are issued both by “independent” shadow banks (non-deposit institutions, or shadow banks) and by banks.
“Examining how these changes affect the sensitivity of the financial sector to macroprudential regulation, we conclude that although increased capital or liquidity requirements decrease credit granting activity, both in the initial scenario (1960s) and in the recent (2020s), the effect is less pronounced in the subsequent period, due to the reduced role of credit intermediation in banks’ balance sheets”, reveals the study.
The replacement of bank balance sheet loans with debt securities explains why there is a very modest decline in lending across all banks, despite a large contraction in bank balance sheet loans.
“In general terms, we see that the intermediation sector has undergone a significant transformation, with implications for macroprudential policy and financial regulation”, advances the study.
“We document that the weight of private loans in the global balance sheet has decreased from 60% in 1970 to 35% in 2023, while the weight of savings deposits has decreased from 22% to 13%. Furthermore, the percentage of loans to banks’ assets decreased from 70% to 55%. We developed a structural model to explore whether technological improvements in securitization, changes in savers’ preferences for deposits, and changes in implicit subsidies and the costs of banking activities can explain these changes”, says the study signed by Greg Buchak, Gregor Matvos, Tomasz Piskorski and Amit Seru.
“Banks’ share of global credit – what the paper refers to in academia as the “share of information-sensitive loans” – has not declined further since the 2008 financial crisis, despite even stricter regulations, and a lot of money has remained on deposits despite negligible interest rates,” he adds.
But the most interesting aspect of the paper is its argument that the radical reshaping of the lending ecosystem over the past few decades means that the banking sector could handle much more stringent capital requirements without massively reducing credit provision – the biggest argument against such measure.
While the increase in banks’ capital requirements results in a significant decrease in credit on the banks’ balance sheets, there is simultaneously an increase in loans through debt securities that replace, albeit imperfectly, loans on the balance sheet of information-sensitive banks, reveals the study.
“It makes sense that as loans move from banks to markets, they will become less sensitive to changes in banking regulation. This may explain why the global percentage of bank loans has stabilized since 2009, despite the entire Dodd-Frank debate”, says the FT.
The 2023 bank failures in the United States have once again highlighted the fundamental issue of banking vulnerability, rooted in the high financial leverage used by banks.
The FT writes that banks’ high leverage is largely a byproduct of the safety nets built into insured deposit financing and banks’ ability to issue money as credits.
“The ongoing regulatory discussion, including the final phase of Basel III, aims to address this vulnerability by considering increased capital requirements for banks,” the article adds.
Critics of such proposals express concerns that increasing bank capital requirements will have major adverse effects on aggregate credit and the broader economy.
Analysis of the NBER paper suggests that banks are now much less important for providing credit than they used to be. “Our structural model indicates that increasing banks’ capital requirements would have only modest adverse effects on aggregate credit and would mainly lead to the reallocation of credit from banks’ balance sheets to debt securities,” he says.
In this regard, the analysis suggests that banks are now much less important for providing credit than they used to be.
“Our structural model indicates that increasing banks’ capital requirements would have only modest adverse effects on aggregate credit and would mainly lead to the reallocation of credit from banks’ balance sheets to debt securities”, highlights the analysis.
Of course, this “credit reallocation” can have downsides, even if the overall amount of credit does not change much. “Eliminating bank risks makes this part of the financial system safer, but the risks do not disappear. They simply take on another form”, concludes the FT.
