Global shadow banking system

Seventh report of the Financial Stability Board

The FSB’s Global Shadow Banking Monitor Report is issued once a year and was published for the seventh time on 7 March 2018. The Monitor Report collates the results of the analysis of global trends and risks in the shadow banking sector based on data to the end of 2016. This year’s report looks at 29 nations that account for 80% of global GDP with Luxembourg included for the first time.

The FSB defines shadow banking entities as “credit intermediation involving entities and activities (fully or partially) outside the regular banking system”. The main players are money market funds, investment funds that use leverage and securitisation vehicles. Shadow banking entities can make a valuable contribution to corporate finance above and beyond bank funding and economic growth. However, the wrong incentives and a lack of transparency in this sector are considered some of the factors that triggered the financial crisis in 2007-2009.

The FSB conducts monitoring through an activity-based measure where the authorities limit the focus to the market activities in the non-banking sector where financial stability risks from shadow banking can occur. In this case it’s maturity and liquidity transformation and leverage effects that are observed in particular.

Based on this narrow understanding of shadow banking entities, their financial assets grew by 7.6% to US$45.2 bn in the 29 nations observed in 2016. This corresponds to around 13% of these nations’ financial assets worldwide. At US$14.1 bn, the shadow banking sector in the US accounts for the biggest proportion and comprises about 31.3% of the global shadow banking sector followed by China at US$7.0 bn. (15.5%).

Source: data from FSB, own diagram

Moderate growth of the shadow banking sector in Germany

According to the data collated by the FSB, the shadow banking sector in Germany is estimated to be worth about US$1.7 bn. This translates into growth of 5.9% compared with the previous year. The shadow banking sector in Germany is primarily composed of activities from collective investment vehicles (e.g. investment funds and insurances). Lagging way behind are activities due to securitisation-based funding for banks and non-banks. The FSB attributes a similarly large proportion of the German shadow banking sector to activities in the shadow banking sector that involve providing short-term finance (e.g. consumer finance and auto finance). At 10%, this sector demonstrated the strongest growth in Germany last year. On the other hand, activities involving securities lending and providing guarantees play no significant role in the shadow banking sector in Germany (see graphic).

Source: data from FSB, own diagram

Private credit funds on the rise in Germany

Due to higher capital requirements for banks since the financial crisis, financing investment projects by shadow banking entities is continuing to be more popular in Germany too. Where banks can no longer provide certain credits, private credit funds are increasingly filling the gap. According to PEI Media, a specialist in providing data on alternative asset classes, 50 private credit funds are now operating in Germany. A large proportion (79%) focuses on extending credit to companies. Some 12% provide real estate financing and 9% financing for infrastructure projects. The providers are often financial investors who, in comparison with conventional banks, are much more flexible and can provide credits for large investments, planned acquisitions or short-term liquidity more quickly. These advantages are reflected in higher prices. Therefore, financing via private credit funds is only worthwhile where sales growth is high, as part of a large financing mix or if no alternative financing is available at short notice. Although financing by house banks is widespread in Germany and reservations about financial investors continue to exist, the demand for financing outside the banking sector is expected to rise.

An example of this worth mentioning is the conclusion of one of the first private debt transactions in Germany announced at the beginning of April 2018. The acquisition of the Halex Group (a leading manufacturer of extrusion tools in Europe) was financed for Bencis Capital Partners in conjunction with other financial investors (including Idinvest Partners and CVC Credit Partners). The Muzinich Private Debt credit funds set up for the purpose currently has an investment volume of US$1.5 bn spread among 32 medium-sized enterprises in Europe.

Financial investors are still seeking profitable investments due to the ongoing low-interest phase and it’s unlikely that regulations for high-risk financing in medium-sized enterprises will be relaxed. However, we can assume that this trend towards alternative types of financing will persist for the next few years.

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Johannes Kühn
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Sebastian Eurich
+49 40 32080 4382