Some of Britain’s biggest lenders have been accused of failing to come clean about the full extent of loans to so-called ‘shadow banks’ as fears grow that a recent spate of corporate collapses in the US could trigger another global financial crisis.
HSBC and Barclays were among big European banks accused of ‘very poor disclosure’ over how much money they have lent to this opaque part of the financial system, also known as the ‘non-bank’ lending market.
Bank of England Governor Andrew Bailey has warned that ‘alarm bells’ are ringing after the collapse of sub-prime vehicle finance provider Tricolor and another US firm, car parts maker First Brands, earlier this year.
The failure of the two firms prompted Jamie Dimon, boss of America’s biggest bank JP Morgan, to observe that ‘when you see one cockroach, there’s probably more’, implying more dangers could be lurking in the non-bank sector.
Shadow banks have become a vital source of funding for consumers and firms as big name lenders have retreated from riskier funding deals since the 2008 financial crisis.
They promise higher returns for investors than the big banks, but lack transparency and are unregulated, meaning they don’t have to disclose financial details.
Concern: Bank of England Governor Andrew Bailey has warned that ‘alarm bells’ are ringing
And their backers, who include fund managers, insurers and wealthy individuals, can lose all their money in a blow-up.
Mainstream banks are exposed to this risk too as they lend direct to the shadow banks.
A risky form of this lending, known as ‘private debt’, has expanded rapidly in recent years and is set to account for £2.1 trillion of all lending in 2029, up from £1.2 trillion last year.
Barclays, which has set aside £110 million to cover losses on dud Tricolor loans, has total exposure to private debt – defined as ‘lending done outside banks and public debt markets’ – of about £20 billion, mostly in the US. But it declined to say how much it had lent to non-depository financial institutions (NDFIs) – a broader group of non-banks that include insurers, pension providers, private equity groups and hedge funds.
NDFIs provide services similar to those of traditional banks but crucially do not take deposits from the general public and are not regulated as lenders.
In a recent note, credit ratings agency Fitch warned that lending by these non-banks, while still niche, was becoming increasingly complex, meaning ‘a financial shock event could reveal unexpected transmission channels’ to the wider system.
It risks creating a domino effect similar to the 2008 crash when a collapse in the US mortgage market spread to other parts of the banking sector through a web of interlocking deals and financial products.
Delivering its results last week HSBC said its exposure to private credit was ‘small’ and in the ‘single digit billions’. But the bank refused to say what its NDFI exposure was outside the US, where regulatory filings show it at £7.3 billion, meaning there could be even more shadow bank loans on its books.
It came after HSBC’s finance director Pam Kaur warned last week of knock-on ‘second-and third-order risks’ from another private credit blow-up.
Sheel Shah, banking analyst at JP Morgan, said the sell-off in bank shares ‘was triggered by poor risk management, but more importantly, very poor disclosure in relation to NDFIs globally across the banking system’.
US banks are better at revealing how much they were on the hook for, he added, but ‘European bank disclosures were worse’.
The amount lent to shadow banks by mainstream lenders is small compared with their other loans but it is growing, with HSBC recently launching a £38 billion private debt fund that focused on Asia, its biggest market.
Fitch recently said the private debt sector would ‘benefit from increased transparency, as more consistent disclosures would help market participants gauge risks and resilience as the sector evolves’.
It also warned that the sector was showing ‘bubble-like attributes’, including ‘rapid growth and financial innovation, heightened competition, growing retail participation and rising borrower leverage’.
Bailey has ordered a stress test of the shadow banking sector as fears grow that loose lending by private equity firms and hedge funds could pose a big risk to the mainstream banking sector.
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