Shadow Banks Rise as Traditional Lending Shrinks

Key Takeaway

• US banks' share in private lending dropped from 60% in 1970 to 35% last year, with loans as a percentage of bank assets falling from 70% to 55%.
• The growth of "shadow banks" like bond funds has significantly contributed to this shift, indicating a major transformation in the lending ecosystem.
• Despite stricter regulations post-2008 crisis, the banking sector's ability to extend credit remains robust, suggesting it could handle even tougher capital requirements.

Navigating the Shadows: The Transformation of US Lending

In the ever-evolving landscape of the US financial system, a significant shift has been underway, reshaping the traditional banking sector and giving rise to the prominence of "shadow banks." This transformation, detailed in a recent NBER paper, reveals a stark decline in the market share of US banks in private lending, which has plummeted from 60% in 1970 to a mere 35% in the last year. This seismic shift is further underscored by the reduction in loans as a percentage of bank assets, from 70% to 55%, and a notable decrease in the share of household wealth held in deposit accounts, from 22% to 13%.

The driving forces behind this shift are multifaceted, encompassing the advent of financial technologies such as securitization and the tightening grip of regulations on traditional banking. These factors have collectively nudged capital towards alternative avenues, including investment funds and bond funds, marking a pivotal transition in the landscape of US lending.

The Resilience Amidst Regulation

Interestingly, despite the dramatic transformation in the lending ecosystem, the overall share of lending by banks has not witnessed a significant downturn since the 2008 financial crisis—a period characterized by an onslaught of stringent regulations. This resilience suggests a potential for the banking sector to endure even more rigorous capital requirements without drastically curtailing credit extension. The NBER paper posits that as lending has gradually migrated from banks to markets, its sensitivity to changes in bank regulation has diminished. This development holds profound implications, especially in the context of the ongoing debates surrounding the Basel II "Endgame" rules, which have stirred considerable unrest among banking institutions.

The Double-Edged Sword of Risk Reallocation

The transition from traditional banking to shadow banking is not devoid of risks. While this migration may ostensibly render the banking sector safer by dispersing risks, these risks do not simply dissipate. Instead, they transform and find new homes within different segments of the financial system. The NBER paper sheds light on the reallocation of credit, indicating that although the total volume of credit may remain relatively stable, the distribution and management of associated risks have undergone significant changes. This reallocation prompts critical reflections on the stability and safety of the broader financial system, as risks previously centralized within banks now diffuse across a less regulated shadow banking sector.

The evolution of US lending from traditional banks to shadow banking entities encapsulates a complex narrative of innovation, regulation, and risk reallocation. As the financial landscape continues to morph, the implications of this shift extend far beyond the confines of banking, touching upon the broader contours of economic stability and financial security. The journey into the shadows of banking is fraught with challenges and opportunities alike, beckoning a nuanced understanding of the intricate dynamics at play.