As banks find their margins squeezed on traditional lending and payments activities, nonbank credit and financing—supported by technological innovation—is growing exponentially.
INSTITUTIONAL INVESTOR INTEREST
Pension funds, hedge funds and mutual funds are, for example, buying bonds to finance investments that require long-term funding, such as bridges, motorways and other infrastructure. The FSB report shows that one of the most dynamic Munfi subsectors in 2013 were trust companies, which grew at a rate of 42%.
A Goldman Sachs study published in March estimated that more than 7% of US banking profits are at risk of leaving the banking sector in the next five years as a result of disintermediation by nontraditional players. The study, which sees both regulations on the banking sector and new technologies as the engines of shadow banking, said that around $11 billion out of $150 billion in 2014 could leave the sector.
“Since the financial crisis, commercial banks are much less interested in long-term loans for regulatory reasons. This leaves [openings] for others, mainly insurance companies or other investors such as pension funds. For these investors, who are seeking long-term opportunities with steady returns, investment in infrastructure is the ideal opportunity,” says Daniel Berger, director of insurance at BearingPoint in Zürich. Berger says that this is the case in Europe, but similar trends are common around the world, from the development of shadow banking in China to the funding of infrastructure projects Latin America.
The emergence of shadow credit can help support economic growth, but it also comes with its own risks. “It is important to recognize that shadow banking in itself is not a bad activity,” says IMF’s Kodres. “The potential downside of that is that people do not understand the risks that they are taking or that there is too much overall generic credit being extended out there—whether it is in shadow banking or in traditional banking—that is not priced properly and hence is not taking into account the true underlying credit risk of the borrowers. That is when we usually run into difficulties.”
Risks aside, this market continues to grow, and other forms of alternative credit are developing, often supported by new technology. A study published in February by the Cambridge Centre for Alternative Finance (CCAF) at the Judge Business School showed that the European online alternative finance market, including the United Kingdom, grew from €487 million ($516 million) in 2012 to €1,211 million in 2013 and hit €2,957 million in 2014, with an impressive average yearly growth rate of 146%. Wide differences, owing to uneven regulation as well as to cultural reasons, are detected among the different countries. The UK is by far the largest market for nonbank credit in Europe, with a total of €2.3 billion in outstanding debt and a 168% year-on-year growth rate, aided by a new dedicated regulation governing the digital alternative financial sector. Other large markets include France, Germany, Sweden, the Netherlands and Spain, while Italy is lagging behind.
“We wanted to carry [out] a benchmark study for Europe and focused on online alternative finance,” said Robert Wardrop, executive director of the Centre for Alternative Finance, adding that the online aspect “is important because there is a social engagement dimension to online finance which distinguishes itself from other forms of shadow banking.”
In the UK the sector is attracting institutional investors. “As a result the growth rate in the UK is outpacing the rest of Europe,” says Wardrop. “You can see it: The London metro is full of advertising for peer-to-peer lenders.”
The CCAF study, co-authored with EY and 14 leading industry associations, showed not only the rapidity of growth of shadow banking in Europe but also the way that growth is shaped by cultural differences between countries. “The Netherlands and Spain have relative and absolute bases of strong growth in rewards-based crowdfunding, which has a philanthropic dimension to the investment decisions,” Wardrop said. The study—based on 255 leading platforms in Europe—is believed to capture 85% to 90% of the European online alternative finance market.
Several factors are driving growth in these new forms of finance, notes Wardrop. He cites low interest rates—which are pushing investors to seek better returns—as well as the “significant loss of trust in financial institutions.”
“But our view at the Centre it is that yes, all of this has possibly accelerated the development, but there is a more fundamental trend going on beneath all of this, and it is a technology-driven trend. At the end of the day technology is the big enabler. And what does technology enable? At a very basic level it helps match providers of funding with users of funding. It enables the disintermediation of incumbent institutions—and this is only the beginning.”
For Latin America and other countries, P2P finance represents a new way to get cheap funding. Cosentino’s Afluenta is raising capital to expand into Peru, Colombia and Mexico.