As banks find their margins squeezed on traditional lending and payments activities, nonbank credit and financing—supported by technological innovation—is growing exponentially.
Alejandro Cosentino, CEO and founder of Afluenta, sends a clear message: Using big data and new technology, Argentina’s first peer-to-peer lending (P2PL) firm says it connects borrowers and lenders better than banks. It lends at lower rates and rewards investors with higher yields. Everyone—except traditional commercial banks—is better off, including Afluenta—which takes a 6% fee.
Launched in 2012, Afluenta has facilitated 1,300 loans for a total of $4 million. Each loan amounts, on average, to $3,000, and it is usually split among more than 120 lenders who share its risk. The Argentine group is small, compared to P2PL firms in the United States, but its business model is similar.
Since its launch in 2007, San Francisco‒based Lending Club has facilitated over $7.6 billion in loans, including $1.4 billion in the last quarter of 2014. The group, which counts US former Treasury secretary Larry Summers as a board member, made its stock debut in December 2014. Lending Club defines itself as the world’s largest online marketplace connecting borrowers and investors. The outfit is focused on gaining size—it has announced a flurry of partnerships with firms around the world, from Google to Chinese e-commerce retailer Alibaba.
From Latin America to the US, Europe and China, peer-to-peer lending is growing, and it is just one of the many ways in which credit is expanding outside the realm of regulated banks. In P2P lending, individual borrowers are given a risk score (which generally is based on their credit score from traditional scoring firms and their application—and which the software evaluates and spits out in a matter of minutes), and their rate reflects that. Investors include individuals and institutions.
But P2PL is just the latest incarnation of shadow banking. Traditionally labeled as shadow banking for its hidden nature, it comprises the extension of finance and credit to individuals and corporations through nontraditional, nonbank channels. It includes all the players engaged in credit provision that are not subject to regulatory oversight, along with financial activity of more traditional intermediaries that is not subject to oversight.
It incorporates everything from lending between individuals supported by peer-to-peer lending sites to the explosion of asset-backed bonds and other credit products to corporations and to fund long-term infrastructure projects, where financing is provided by institutional investors—such as insurance companies and pension funds. As the availability of banks loans and of public finance is shrinking, more financing for infrastructure is being provided by institutional investors, either directly or indirectly.
Paul McCulley, US economist and former managing director at global investment management firm Pimco, coined the term “shadow banking” when the securitization of home loans made up a large part of the assets packaged and sold to nonbank investors. It came to represent one of the many deficiencies of the financial system ahead of the financial crisis. Since then, increased regulation in the US and in Europe have helped dismantle most of what was once considered shadow banking. But other forms of nonbanking credit are emerging, this time supported by technological innovation.
The Financial Stability Board (FSB), which runs a yearly study on 20 jurisdictions plus the euro area, has a very wide definition of shadow banking, including all nonbank financial intermediation in aggregate. The board defines it as the Monitoring Universe of Non-Bank Financial Intermediation (Munfi). The 2013 amount of Munfi was $75 trillion, up over the previous year by $5 trillion, or 120% of total global GDP. Munfi hit a record high at 124% of GDP in 2007 and fell to a post-crisis low of 112% in 2011.
Worldwide, peer-to-peer lending is growing, and credit is expanding outside the realm of regulated banks.
“What happened,” says Laura Kodres, chief of the Global Financial Stability Division at the International Monetary Fund, “is that other types of shadow banking expanded—in particular, the use of investment funds that are now supplying credit to small enterprises, leveraged loans [loans to companies or individuals that already have high debt levels], and project finance.”
For example, the nonbank share of leveraged loans as a percentage of all leveraged loans in the US has grown from about 20% to 80%, she says. “A lot of that credit activity is now taking place outside of banks, for instance among credit-focused mutual funds.”
Regulation imposed on banking after the financial crisis, such as capital constraints from Basel III regulations, are setting limits on the activity of traditional banks and spurring other forms of credit. “Lending is actually a more expensive activity for the traditional commercial banks, and nonbanks see this as an opportunity to be able to provide credit at lower cost, in part because they do not have to follow the same capital requirements and they do not have to follow the same liquidity requirements that traditional banks do,” notes Kodres.