The rise of “shadow credit” as consumers turn to risky credit

UK bank chiefs have warned that more consumers are relying on “shadow lending” during the cost of living crisis as they take out risky loans from the more obscure corners of the financial system.

“I think the concern is that people are increasingly turning to unregulated lending,” David Lindberg, chief executive of retail bank Natwest, told the Financial Times.

“If you look back 15 to 20 years ago, you would find that the credit stress was in the banking system. Today, it is included in ‘buy now, pay later’ utility bills and collections from government agencies and, in many cases, from less regulated, high-interest loan providers or ‘friends,’” he added.

Despite rising interest rates and double-digit inflation, high street banks such as HSBC, Lloyds, NatWest and Barclays have shown no signs of stress in their loan portfolios. Gary Greenwood, an analyst at Shore Capital, said arrears — or overdue payments — are still low at the big banks.

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But even as analysts cheer the resilience of big banks’ balance sheets, some bankers have warned that the unregulated shadow lending sector could mean the financial system is less stable than it appears.

Nigel Terrington, chief executive of Paragon Bank, said: “Shadow banks tend to play on the riskier edge of credit markets by exploiting regulatory differences. With [regulatory] The requirements for banks will become more and more stringent, and this situation will only get worse.”

Greenwood added: “Banks have been risk averse since the financial crisis and that risk has been pushed into shadow banking. All the bodies are buried here.”

Riskier types of credit are becoming more common as the cost-of-living crisis pushes people into more expensive forms of short-term credit.

According to research by the Center for Social Justice, a British think tank, more than 1 million people borrowed from illegal moneylenders in 2022, up from 310,000 in 2010.

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According to the Financial Stability Board, an international organization of major economies, in 2021 non-bank financing amounted to $239 billion worldwide. Shadow banking activity currently accounts for nearly half of the world’s total assets. Shadow banking activity in the UK, based on a narrower measure of non-bank funding, reached $1.7 billion, up from $900 billion in 2008, according to the FSB.

Gerard Lyons, chief economic strategist at investment manager Netwealth, said people should generally be “wary” of shadow finance. “We need to distinguish between areas of shadow banking that cause financial instability and those that finance parts of the market that need it, where banks are not filling the space,” he added.

The Bank of England he said last month that it monitors shadow banking activity, conducted a “systemic stress exercise” among non-banks as well as traditional lenders “to help us map the risks.”

Andrew Bailey, governor of the BoE, said the “problems” associated with shadow banking had “striking similarities to the age-old challenges of finance, such as leverage and interconnectedness with other parts of the financial system, giving rise to spillovers and systemic consequences.” “.

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Buy now, pay later – a popular form of short-term credit that has faced criticism over the affordability of its loans – will be regulated by the Financial Conduct Authority. According to government plans unveiled in February, the watchdog would be empowered to, among other things, ban lending to companies if they do not carry out adequate credit checks.

Additional reporting by Chris Giles