Not five minutes ago I received an email titled: “Personal Loans Trusted Lenders Ready to Lend up to $35,000…”
This was the fifth or sixth email of this nature I have received just this morning. Of course, most of these are spam, filled with malware or links to nefarious sites that will do great damage to my computing devices. I hope it goes without saying you should always check the validity of any email address and do not click on anything even remotely suspicious.
Yet some of these, it turns out, are quite legitimate from basically legitimate lenders. No, not banks. But lenders of a different sort in an industry that has come to be known as “Shadow Banking.”
Recently, Lisa Brammer and I have been writing a lot about financial literacy and doing the right things to manage our finances and debt. I think this one should go under the general heading of ‘buyer beware’ or ‘if it seems too good to be true it probably is’.
Shadow Banking is not really new, and previously has had pronounced, and downright insidious effects on the economy. Those of you who recall our last economic recession know that it was principally caused by the subprime mortgage crisis in 2007-2008. In fact, our recession led to a worldwide recession from which we have only recently recovered. Shadow Banking was a source of many of these so-called subprime loans. Perhaps you thought that was the last we would have heard of this ‘serpent’ in the financial garden. Think again.
Shadow Banking has once again grown to be a huge source of competitive lending offering low rates and quick cash for everything from home mortgages to auto loans.
According to Wikipedia “The shadow banking system is a term for the collection of non-bank financial intermediaries that provide services similar to traditional commercial banks but outside normal banking regulations. (emphasis added)”
That last is an important caveat.
Wikipedia goes on to add “The phrase ‘shadow banking’ contains the pejorative connotation of back alley loan sharks. Many in the financial services industry find this phrase offensive and prefer the euphemism ‘market-based finance’.”
No less an authority than former US Federal Reserve Chair Ben Bernanke defined Shadow Banking further in November 2013: “Shadow banking, as usually defined, comprises a diverse set of institutions and markets that, collectively, carry out traditional banking functions — but do so outside, or in ways only loosely linked to, the traditional system of regulated depository institutions. Examples of important components of the shadow banking system include securitization vehicles, asset-backed commercial paper [ABCP] conduits, money market funds, markets for repurchase agreements, investment banks, and mortgage companies.”
The long and short of it is while they may look like banks, act like banks, lend money like banks they are not banks. While they have become subject to some level of regulation, they certainly don’t provide safeguards for your money as do traditional banks and the Federal Deposit Insurance Corporation (FDIC).
Yet the industry has once again become huge. Like $52 trillion huge.
In an article posted on CNBC.com (“Shadow banking is now a $52 trillion industry, posing a big risk to the financial system” read the article here), reporter Jeff Cox says this is a 75% increase since the last financial crisis of 2007/2008.
“Nonbank lending, an industry that played a central role in the financial crisis, has been expanding rapidly and is still posing risks should credit conditions deteriorate” writes Cox. “…these institutions helped fuel the crisis by providing lending to underqualified borrowers and by financing some of the exotic investment instruments that collapsed when subprime mortgages fell apart.”
Cox continues: “The U.S. still makes up the biggest part of the sector with 29% or $15 trillion in assets, though its share of the global pie has fallen. China has seen particularly strong growth, with its $8 trillion in assets good for 16% of the total share.”
Quoting no less an authority than J.P. Morgan Chase CEO Jamie Dimon (from his annual letter to investors) “The growth in non-bank mortgage lending, student lending, leveraged lending and some consumer lending is accelerating and needs to be assiduously monitored,”
Additionally DBRS, a bond rating agency, said: “The exposure of the global financial system to risk from shadow banking is growing…Weaknesses in these shadow banks arising from these activities could result in runs that could instigate or exacerbate financial market stress.”
To be fair, the industry says that they provide an important function to the economy by providing access to loans and other financial instruments that can help those who cannot qualify for traditional loans. Perhaps so.
Yet, according to Cox, “DBRS identified three specific risks that shadow banks pose under times of market stress: That they are ‘not structured’ to deal with periods of low liquidity and heavy withdrawals; a lack of experience in dealing with periods of weakening credit conditions, and a lack of earnings diversification that would hurt them when parts of the markets deteriorate.”
So, some word salad there, but the bottom line is that consumer debt has grown to historic proportions once again and any volatility in the economy could create a tipping point we can’t recover from very easily. Shadow Banks are not equipped to handle sudden reversals in revenue inflows. Perhaps making this even worse is the fact that this just does not apply to mortgages, the industry has expanded to student loans, auto loans and other consumer credit instruments so the impact could be even more widespread should conditions suddenly change.
So, is the serpent back in the garden? Perhaps; perhaps not. Yet the hissing is unmistakable.
A. Alliance Collection Agency, Inc. is a full service, licensed accounts receivable management and debt collection agency providing highly effective, customized one on one management and recovery solutions for our business partners. Founded in northern Illinois in 2005, we have been proudly improving the bottom-line on behalf of our business partners in and around Chicagoland for over 14 years.
image provided by: wikimedia.org