Shadow Banking Is a New Culprit in Systemic Risk: Fitch

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.