Bank-to-Nonbank Lending Breaches $1TN

Over one trillion dollars. That’s what the Federal Reserve’s weekly H.8 report started showing for the week ending January 24, 2024. The report tracks the assets and liabilities of the nation’s largest banks, and for the that week, the aggregate loan amount to nonbank, non-depository lenders, i.e. private credit funds, hedge funds, investment companies, and fintechs, breached the $1 trillion mark, up 12% YOY for the trailing twelve month period. Both Bloomberg and the Financial Times picked up on the breach, with each (rightfully so) reporting that the magnitude of the amounts outstanding could pose systemic risk to the financial system. Essentially, banks are bulking up their balance sheet assets with loans to private credit, fintech and investment vehicles, which in turn, are lending to borrowers that the banks wouldn’t otherwise lend to directly. And because these vehicles are unregulated, there’s no top-down oversight to assess and remediate the risk associated with the loans’ ultimate disposition. Hence, calls from EU regulators, the U.S. Office of the Comptroller of Currency, and the U.S. Treasury to push for central bank involvement for greater visibility, governance and enforcement of these unregulated lenders in an effort to fend off a potential dislocation which could trigger a full-blown financial crisis.

As one who generally aligns himself more in the laissez-faire camp of capitalism (broadly), and governmental regulation specifically, I’d be hard-pressed to say that there’s not a legitimate argument here to bring private lender oversight under the purview of central bank authorities. Perhaps a bias I adopted by virtue of living through the Great Financial Crisis, however, given the magnitude and acceleration of bank-to-nonbank lending, in the context of plateauing interest rates and continuing credit tightening among traditional depository institution lending activity, I wouldn’t be surprised to see a ramping up of rhetoric around this issue, nor actual regulation begin being pushed through to bring these nonbank lenders under scrutinous oversight, and subjecting the same to policies aimed at the creation of de-risking guardrails tied to quantum (amount and percentage of overall capital loaned) and creditworthiness.

Notwithstanding the potential for systemic risk that warrants regulatory attention, it ought not be lost that the private credit markets are providing mission critical credit to the economy – in many instances much needed capital and justifiable loans to businesses to make up for the credit tightening that traditional banks and depository institutions have implemented, and still adhere to. These nonbank lenders are stepping in to fill the void in capital allocation needed to fuel economic growth, whether that be through providing working capital to small and medium size enterprises, financing for merger and acquisition activity, or leverage across the private equity spectrum, from venture capital to traditional growth equity and buyout firms.

Hopefully, reasonable heads will prevail in creating smart policy that will both lower the probability of systemic risk to the financial system, and at the same time, continue to provide the necessary capital to productive endeavors that drive economic growth…at least until such time as traditional banks get back in the game and loosen their own lending policies.

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