There was once an old radio show that asked about the evil that lurked in people’s hearts.
“The shadow knows,” intoned the narrator.
Let us soften this formulation a little – who knows what risks lurk on the fringes of the financial sector?
The shadow banks know it.
The banks that lend to them could not knowledge, This means they will likely need to strengthen their know-your-customer and other risk management efforts.
Suffering a (financial) blow that is difficult to estimate
Shadow banking is a collective term for cases where traditional companies have lent money to lightly regulated FinTechs and other “non” traditional financial companies. When the FinTechs and other creditors get into trouble and their finances collapse, the traditional financial institutions suffer financial damage.
In June, the Federal Reserve Bank of New York wrote in a blog post that banks and nonbanks are “closely intertwined” and that the latter rely on banks for term loans and lines of credit. Total lending to shadow banks is estimated to have exceeded $1 trillion in January. Term loans, which are advances from lenders that are repaid by borrowers over time, accounted for just over a quarter of lending to nonbanks, compared with about 15 percent in 2015, the Fed said.
Recently, the Financial Times found that First & People’s Bank, a small Kentucky-based bank, had suffered from defaulting on loans to FinTech company US Credit. According to the report, the Kentucky-based bank, which has a history stretching back more than a century, could be at risk of failure.
A separate report from the National Bureau of Economic Research in April said: “Case studies and regulatory data show that banks continue to face credit and funding risks that, at first glance, appear to have been shifted to NBFIs. There is also contingent liquidity risk from providing credit lines to (non-bank financial intermediaries),” such as fintech lenders.
We are certainly headed toward greater oversight. As outlined in the Financial Stability Oversight Council’s November interpretive guidelines, which took effect in January, the Council can determine “that a nonbank financial company is subject to Federal Reserve oversight and prudential standards and lists the considerations the Council must take into account in making such a determination.” These new rules are intended to create a new framework to gain greater insight into nonbank risks, where banks lend to hedge funds and mortgage lenders and also take on FinTech risks.
The investigations and oversight would take into account “the nature, scope, size, extent, concentration, interconnectedness, or mix of the nonbank financial entity’s activities that could pose a threat to U.S. financial stability.”
For banks, a number of vendors and platforms have introduced Know Your Business (KYB) technologies and solutions to help assess risks during onboarding. For example, Enigma launched its KYB platform in October. Separately, Israeli identity verification company AU10TIX launched its own KYB products and services in February.
The oversight would come as 65% of banks and credit unions have entered into at least one FinTech partnership in the past three years, with 76% of banks considering FinTech partnerships necessary to meet customer expectations, according to research from PYMNTS Intelligence. These partnerships would include lending, which in turn would likely come under greater scrutiny to determine where the risks lie and how much risk there is in the system.
