System-wide market risk stemming from the financial services industry hasn’t conclusively declined since the financial crisis that started more than a decade ago, Fitch Ratings warns in a new report.
Specifically, Fitch pointed to the continued rise of shadow banking as a potential culprit in new systemic risk.
Shadow banking is credit lending and the exchange of liquidity that occurs outside of mainstay financial institutions such as banks and insurance companies.
This darker sector of the financial system has been growing noticeably since the financial crisis, according to the report, “Shadow Banking Implications for Financial Stability.”
Global shadow banking assets reached $52 trillion as of fiscal year-end 2017, up 8.5% year over year, the report noted, citing the G-20 Financial Stability Board. That represents 13.5% of total financial assets.
Of that, the U.S. had almost $15 trillion of these assets, or almost 29% globally, a figure that has stayed relatively flat since 2010. Yet China, with a smaller slice at $8.3 trillion, has filed a compound annual growth rate of almost 60% since 2010 in shadow banking, according to the report.
Chinese regulators, though, increased their oversight over shadow banking in 2018 out of concern, focusing primarily on wealth management and trust products, Fitch said.
In general, banks “have modest direct lending and borrowing exposure to shadow banking, although they face indirect risks including interconnectedness and asset price volatility,” Fitch stated.
The systemic risks shadow banking could trigger might include bank exposure channels, insurance companies and pension funds, according to Fitch. A shadow banking liquidity event could reduce corporate borrowing and increase volatility in asset prices from forced asset sales or huge redemptions.
Fitch pointed to the default of an infrastructure finance company in India in September 2018 that spurred funding problems, causing the country’s supervisors to urge banks to increase loans and asset purchases from these entities to expand liquidity.
Even though India’s shadow banking assets were only 17th globally, not even nearing a trillion dollars as of year-end 2017, shadow banking there has accelerated since the global financial crisis ended, the report noted. It pointed to a “spike in 2017 driven by finance companies providing asset finance and home loans and funds investing in infrastructure loans.”
However, Fitch conceded that credit availability outside the banking system combined with perhaps more transparency and regulatory efforts to control risk without narrowing credit availability can be positive if it “provides additional sources of credit and liquidity to support economic growth.”
But time will tell.
Fitch is watching how shadow banking entities perform through the next credit cycle to judge whether shadow banking will be beneficial or not for the overall financial system.