A shadow
banking crisis erupts
And spare
a worrying thought for the unregulated private credit market and the so-called
shadow banks. The usually staid Governor of the Bank of England, Andrew Bailey,
has already tolled the alarm bell.
In
October, he warned of parallels with the 2008 financial crash, which was
sparked by an American housing bubble fueled by easy credit and the issuance of
risky subprime mortgages, with their subsequent bundling into opaque financial
products that spread risk throughout the global financial system. Risk turned
to contagion.
Will the
global financial system once again be brought to its knees? The private credit
markets have become a major source of funding for businesses. That’s partly
because traditional banks never regained their appetite for riskier lending
after the 2008 crisis, and they have also been restrained because of greater
regulatory scrutiny.
The hedge
funds and private equity firms comprising the shadow banking sector now account
for just under half of the world’s financial assets, worth around $250
trillion, according to the US Financial Stability Board.
The good
news is that unlike traditional and investment banks they’re not using consumer
cash deposits to invest in long-term, illiquid assets; they raise and borrow
funds from investors, who in large part agree for their investment to be locked
up for long periods. That reduces the short-term risks for the shadow banks —
so in theory there shouldn’t be massive runs on them, like, say, what happened
to Lehman Brothers in 2008.
But
that’s in theory. If the private credit market is roiled, there’s bound to be
an impact on other parts of the global financial system. And cash-strapped
governments will be in no position to organize a bailout like in 2008,
particularly at a time of even greater populist revolt. Furthermore, shadow
banks have bet heavily on AI — and the AI boom might be a bubble ready to pop.
It might soon be time to take cover.
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