The capital markets and shadow banking have become the new financing channels for those companies unable to have a traditional bank credit. Some entities such as the real-state sector (socimis in Spanish) or business angels, crowdfunding, the venture capital funds, the closed funds for SMEs and even the hedge funds are included in the shadow banking sector.
There is a lot of documentation that tries to define this general definition. We can affirm that some differences related to geography (China, the US and Europe) and to the credit-oriented product have been found. This supposes a great threat, mainly because of the lack of regulation and the risk assumed by these companies. It is thought that this could be the bubble that will generate the next big crisis.
The truth is that this concept is not new. In the crisis of 2008, these entities contributed to this concept because of their large exposure to mortgage risk products of the famous CDS. In recent years, the shadow banking sector (nowadays “private debt market”) has tripled its size. It is estimated to be around $1.2 trillion (around 40% of the European capital market). With this in mind, we could say that any future crisis will be affected by these agents or vice-versa.
The big question is: are Shadow banking loans just loans that regulated banks decided not to give?
Most of shadow banking companies have more lax regulation, less bureaucracy and restrictions, and more specialization. So, what would happen to the small companies that do not have access to credit or capital due to the demanding risk controls of the regulated entities? Aren’t SMEs the key to the business network and a fundamental part of innovation?
The expansion of shadow banking is mainly driven by regulatory arbitrage, the desire to avoid capital and liquidity constraints. These requirements have been progressively imposed on banks. There is clearly an element of truth in that assumption. Shadow banking has been transformed into a different system that adapts to regulations and relies on technology (Fintech). Adaptation times have been reduced and competition with the established mature banking companies has become evident and continues to increase.
However, the shadow banking would not exist alone. It has been developed because it is a need. Some savers and institutions that represent them want to keep part of their liquidity or improve the return of their investments. At the other end of the chain, productive investors need both financing stability and long-term commitment.
Reconciling these opposing preferences has played a central role in our system, especially with the optionality allowed by technology and access to information. Financial innovation makes it possible for investors to limitlessly reconcile liquidity and profitability. Therefore, shadow banking is only the last phase in this evolution. This process is becoming increasingly sophisticated, complex, and potentially dangerous. However, it is also necessary.