Shadow Banking: Is the Serpent Back in the Garden?

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

Understanding Your Debt and Managing Personal Finances

Receiving a letter or phone call from a collection agency can be both a scary and embarrassing moment.  It is not uncommon for people to ignore collection letters and phone calls simply because they are uncomfortable with the situation. The truth is no one wants to feel embarrassed; it is no fun at all. (How’s that for some good insight)?Receiving a letter or phone call from a collection agency can be both a scary and embarrassing moment.  It is not uncommon for people to ignore collection letters and phone calls simply because they are uncomfortable with the situation. The truth is no one wants to feel embarrassed; it is no fun at all. (How’s that for some good insight)?

Contrary to common beliefs, there is no “typical” debtor. People from all walks of life and socio-economic classes are susceptible to falling behind on their bills. The inability to pay debts can stem from a variety of causes; job loss, prolonged illness, and unforeseen injuries are three common reasons people cite as the cause of their past-due bills.

Another group of people fall behind simply because they have done a poor job budgeting, or have never been taught the importance of money management.

Regardless of the reason, you’ve fallen behind on your bills and have been contacted by a collection agency, now what?

The first thing you should do: Stay calm.

Remember, you are not alone.  Falling behind on your financial obligations is not uncommon in the United States.   Chances are a neighbor, friend, or family member has also been sent to collections at some point in time.

A reputable collection agency will work with you, not against you.  It is important to acknowledge the collection agency and contact them regarding the debt in question.  As a consumer, you have 30 days to dispute certain facts, so it is important to figure out if this debt is yours ASAP.

Once you have established that the debt in question is, in fact, yours do your best to make a payment in a timely manner.  Not all debts are the same; one bill may be for $60 and another $6,000.  If the balance is low, try to take care of it with one payment.  Paying off an old bill feels good, and it’s one less thing to worry about.

Now for that dreaded debt you simply cannot afford to pay all at once.  For some people this amount may be $600,  for others $6,000.  Whatever the number may be for you, it is important to make an effort to pay down your balance.  Contacting the collection agency and setting up a payment plan can stop the phone calls and letters and potentially prevent your credit rating from being harmed.

A recent poll conducted by Harris Interactive found that 57% of U.S. households lived without creating a budget for themselves.

There are some great budgeting resources available online.  I suggest finding one of these sites (I like Nerdwallet. Here is a great post of theirs called Budgeting 101) and planning out your monthly budget.  You may be surprised to find out how you are spending your money.

If you find yourself behind on your bills or cannot afford to pay them, it is important to be proactive. Rather than sticking your head in the sand, utilize all the resources out there, and work with the agency trying to collect the debt. You may be surprised by how helpful a reputable collection agency can be for you. For more information about paying off your debt check out this great resource: Ask Doctor Debt!

Good luck, and remember… it is never too late to improve your credit rating or personal finances.

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

Financial Literacy: How Savvy are You?

Since April is financial literacy month, I thought it would be a good time to discuss the sobering results of the Standard and Poor’s Ratings Services Global Financial Literacy Survey.  The S&P survey is the world’s largest, most comprehensive global measurement of financial literacy.  The results are based on interviews with more than 150,000 people from over 140 different countries, aged 15 and older. Unfortunately, the outcome revealed that worldwide only 1-in-3 (~33%) adults (15 and older) are financially literate.  Sadly, this leaves about 3.5 billion people ignorant of basic financial concepts.

To determine financial literacy, questions were asked that measured knowledge in four basic financial concepts: risk diversification, inflation, numeracy (interest), and compounding interest. A person was considered financially literate if they understood (at least) three of the four concepts.

Here are the questions. Multiple choice answers are in brackets.

RISK DIVERSIFICATION

Suppose you have some money. Is it safer to put your money into one business or investment, or to put your money into multiple businesses or investments? [one business or investment; multiple businesses or investments; don’t know; refused to answer]

INFLATION

Suppose over the next 10 years the prices of the things you buy double. If your income also doubles, will you be able to buy less than you can buy today, the same as you can buy today, or more than you can buy today? [less; the same; more; don’t know; refused to answer]

NUMERACY (INTEREST)

Suppose you need to borrow 100 US dollars. Which is the lower amount to pay back: 105 US dollars or 100 US dollars plus three percent? [105 US dollars; 100 US dollars plus three percent; don’t know; refused to answer]

COMPOUND INTEREST

Suppose you put money in the bank for two years and the bank agrees to add 15 percent per year to your account. Will the bank add more money to your account the second year than it did the first year, or will it add the same amount of money both years? [more; the same; don’t know; refused to answer]

Suppose you had 100 US dollars in a savings account and the bank adds 10 percent per year to the account. How much money would you have in the account after five years if you did not remove any money from the account? [more than 150 dollars; exactly 150 dollars; less than 150 dollars; don’t know; refused to answer].

Here are the answers:

Risk Diversification: Multiple businesses or investments

Inflation: The same

Numeracy (interest): 100 US dollars plus three percent

Compound Interest: More, More than 150 dollars

How did you do?

Worldwide, risk diversification was the least understood concept.  I was surprised by this. I guess a lot of people have never heard of the old adage, “Don’t put all of your eggs in one basket.” Kind of spells it out for you, doesn’t it?

Overall, men fared better than women. Worldwide, 35% of men and 30% of women were financially literate.  People from Northern European countries had the highest scores: 71% of adults in Denmark, Norway, and Sweden understood the concepts. People from South Asian countries had some of the lowest scores, where, at best, 25% are financially literate. Here in the United States 57% of the people passed and in Canada 68% did well. The Republic of Yemen had the lowest score with a financial literacy rate of only 13%.

One of the things I found interesting about the results was that worldwide financial literacy was lowest among adults 65 and older. But as poorly as scores generally were, I found it encouraging that globally and in countries with emerging economies people in the 15-35 age group did the best. This tells me that perhaps there’s been an increase in education for people in these younger age groups.  Hopefully this will translate into higher scores for everyone in the future.

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.