subject: Arun Panchariya: New Types Of Lenders Are Emerging [print this page] Shadow banking, alternative banking, alternative funding etc. are names used on financing services of which many actually are older that what we call banks today. However, this sector has grown substantially since the financial crises in 2008/9. I will in the following mostly use the term alternative banking. Mr. Michel Barnier, the EU commissioner for financial services stated last month according to the Financial Times of London that he assumes shadow banking now represent 25-30 per cent of the worlds financial sector.
Recently we have seen something close to a hype surrounding this area as ex-bankers and others are starting investor funded institutions to meet different funding needs among their company and private clients. Not surprisingly the critics of the sector are also there. There are obviously some executives in existing banks that feel it is unfair that these institutions can grow without the same scrutiny and regulations as the increasingly regulated banks. Also financial regulators are starting to focus on these institutions regarding consumer protection and risks to the financial system.
I am not in the following going to enter into a full blown analysis of these sectors. Others are better positioned to do that. My intention, however, is to point out a few aspects of this development that are not covered in the everyday news articles.
First a few word about what alternative banking is. Actually it can be defined as all commercial funding except equity financing outside the regulated banking sector. Any exact definition is not required except when laws and regulations are considered. Then obviously the scope of these regulations has to be well defined. But some examples could be useful.
The so-called peer-to-peer lenders, which enables individuals to lend typically (but not necessarily) to small business is growing. Here often different Internet solutions are used as an important tool. Another growing funding source is typically large companies (Blue-chip companies) funding their suppliers and customers in a more bank-like way. An example of this is the German multinational Siemens that has put this in place for its suppliers. Big cash rich companies, not at least Chinese are increasingly giving commercial loans to third parties to improve the return on their cash. Private Equity groups are establishing their own leveraged loan arms. The number of credit hedge funds and money market funds are increasing.
I also like to mention another development that is related to the growth of alternative banking which is the new more specialist banks that are being set up or expanded. Examples of this are banks with a lending focus on a specific segment. When these are covered by the existing regulatory regimes I do not think the term alternative banking or funding is the best term for theses institutions. Though, this development is also often included when the development of the alternative banking sector is being discussed.
When the recent development is described, the story line simplified is the following: Due to the new heavy market regulations on banks the natural consequence is the development of institutions outside the scope of these regulations with the competitive advantages this bring with it. In my view this is obviously correct, but only as a part of the driving forces behind the development and most likely not the most important.
Another driving force is the structure of the existing large and many medium sized banks that are extraordinary diverse businesses. So diverse that it is very difficult to find any similar complex organisations outside the finance sector anymore.
Large banks regularly include advising in a wide area of financial and even business matters in general to small companies, individuals as well as to huge corporations. The banks provide everything from consumer loans to complex corporate loans and loans to governments as well as money transfer services. During crises some banks also keep their bad banks as a part of their businesses in spite of the extremely different business logic between bad banking and regular banking. Further you have foreign exchange, brokering of shares and bonds as well as managing huge retail networks of bank branches.
It should not be surprising, with this enormous diversity within many of todays banks different businesses, that it is highly likely that there is a huge market for more focused institutions in financial subsectors. It would not be surprising if it is better ways to fulfil many of the different requirements that many customer groups have with more focused institutions as is common outside of the banking sector. In my opinion it is therefore likely that this development will continue as different needs in the market can better and more efficiently served.
It is important to note that the alternative banking sector implies that the established banking will disappear. It is quite the opposite. The alternative banking sector often works closely with banks and can thrive together. For example when blue-chip companies give loans to their suppliers this often happens in cooperation with banks that also give loans.
Some new financial institutions will prove not to have a viable business model, but other new models will prove to fill real needs in the market. This is nothing special and new with this. This the way a capitalist market system is supposed to work.
Some experts think that the quicker recovery from the financial crises in the US is due to the fact that European banks intermediate more of the financial flows. The leaner and more focused alternative financial institutions do not stop working to serve their customers in the same way banks do during crises. At least the more focused banks are quicker to adjust to new circumstances and thus recover quicker.
It is not surprising that the development of new financial institutions will be a demanding task for the authorities. However they should try to encourage the development of new institutions instead of discouraging them. It would benefit business as a whole and the society if the financial system gets more efficient. But regulations are necessary. What is extremely important is to accept to have different regulations for different institutions. Simpler and leaner institutions do not require as complex regulations as complex huge banks.
Regarding regulation it is important to remember the difference between consumer protection and regulation that tries to control systemic financial risks. Especially demanding is to identify and regulate structural risks in connection to alternative banking. It is not necessarily so that systematic risk only can be linked to gigantic institutions. Also peer to peer systems can be interconnected to many institutions. In my opinion it is required to do more research in this area to be able to make the right choices regarding regulation and priorities regarding monitoring. This will help the authorities to get the most efficient regime in place and help to avoid that the different sectors of the alternative banking sector are neither over-regulated nor under-regulated.
Mr. Arun Panchariya is specialising in cross border transaction between Asia, Europe and the US
