Lockhart says shadow banking could be the trigger for the next financial crisis
The former President of the Federal Reserve Bank of Atlanta, Dennis Lockhart, has warned that America’s extensive shadow banking system could trigger the next financial crisis. The network of non-bank financial institutions known as the ‘shadow banking system’ in the US has grown sharply since the financial crisis in 2008. It is now the largest shadow banking network in the world, with a value of $24 trillion in 2014, according to Reuters.
Shadow banking a bigger risk factor than Trump’s financial policies
What is shadow banking? The term ‘shadow banking’ commonly refers to financial intermediaries, such as non-bank securities companies and hedge funds, which are involved in the creation of credit but are not regulated in the same way that conventional banks are. Unlike the traditional banks which typically finance real estate development, these investment companies are often established as subsidiary businesses and act as intermediaries selling financial securities (such as hybrid real estate financing products) to raise financing.
They make a profit on the margin between their loan income and the dividends they pay out to investors. While there is nothing illegal about this, the problem is that they are only lightly regulated despite being vulnerable to the same set of risks as ordinary banks.
It is no exaggeration to say that in the United States, which has grown to account for about half of the world’s shadow banking market, this is potentially a ticking time bomb. According to CNBC, Dennis Lockhart’s view is that, “In the aggregate it [the shadow banking system] adds up to a fair amount. Perhaps those entities will grow to be large enough and something could happen in that sector.”
“The pendulum of regulation tends to swing, and understandably after the crisis it swung very far in one direction. There’s been tremendous progress in terms of the resilience of the financial services industry across the U.S. and the rest of the world, and it think it’s perfectly appropriate that the pendulum swings back – it’s just a question of how far back it swings,” he said.
Compared to the risks that shadow banking poses, the risks of President Trump’s financial policies to the banks look relatively tame.