In January 2023, US banks gave out $1 trillion of loans to non-regulated “shadow banks.” Outstanding loans to non-depository financial entities such as private equity firms and hedge funds reached $1.0024 trillion last month, representing a 12.16% year-over-year surge from the same period in 2023. This has become one of banking’s fastest-growing businesses at a time when lending volumes overall are growing at a slower rate.
However, the sharp rise in lending to shadow banks has raised concerns among regulators over potential systemic risks. These so-called shadow banks are often less regulated and many lend money to enterprises where returns may be greater but risks are much higher than what a regulated institution would be able to tolerate. Experts have warned that such loosely regulated financial institutions have exposed banks to lower-quality loans, which could lead to greater financial instability if there were a widespread default on these loans.
Several major banks including Citigroup and Wells Fargo have strengthened their ties with alternative asset lenders. This trend is likely driven by the desire to diversify their portfolios and take advantage of the growth opportunities offered by shadow banks. However, this also exposes them to greater risk as they are increasingly lending money to unregulated entities with higher levels of debt risk. As such, regulators will continue to closely monitor this sector and work towards finding ways to mitigate these risks while still allowing for growth in the economy.