The Shadow Banking Risk Continues To Rise
By
Avi Gilburt
Our latest article on bank safety: The Shadow Banking Risk Continues To Rise
The Financial Stability Board (FSB) has recently published its annual Global Monitoring Report on non-bank financial intermediation (NBFI).
According to the report, in 2024 the NBFI sector grew 9.4% - double the pace of the banking sector (4.7%) - increasing its share of total global financial assets to 51% ($256.8T), broadly in line with pre-pandemic levels.
Source: FSB
Interestingly, the growth rates of hedge funds and trust companies were among the highest.
Source: FSB
Most importantly, the financial assets of entities classified under the FSB’s narrow measure -the subset of NBFI that engages in credit intermediation and may give rise to financial stability risks (i.e., “shadow banks”) - increased 12.7% in 2024 to reach $76.3T.
As the chart below shows, shadow-bank assets have posted very strong growth over the past ten years.
Source: FSB
If you follow our banking work, you’re well aware of the close interlinkages between traditional banks and shadow lenders. That said, it’s once again worth noting what the FSB highlighted in this report.
According to the FSB, there are three main forms of linkages: (i) funding and deposit relationships, where non-banks place deposits with banks; (ii) lending, repo, and other credit exposures from banks to non-banks; and (iii) holdings of bank-issued securities by investment funds, insurers, and pension funds. Funding and credit exposures are frequently complemented by market-based connections through derivatives, securities financing, custodial and other client services, as well as common asset exposures.
The FSB also highlights that shadow banks have vulnerabilities related to leverage, maturity mismatch, and liquidity mismatch, which can amplify shocks in the financial system—for example, sudden corrections in asset prices or bouts of financial market volatility.
This is another reminder that shadow banks - given their growing size - are becoming one of the most important risk considerations for traditional banks.
Bottom line
Believe it or not, there are more major issues on the larger bank balance sheets as compared to smaller banks, which we have covered in past articles. Moreover, consider that there was one major issue which caused the GFC back in 2008, whereas today, we currently have many more large issues on bank balance sheets. These risk factors include major issues in commercial real estate, rising risks in consumer debt (approaching 2007 levels), underwater long-term securities, over-the-counter derivatives, high-risk shadow banking (the lending for which has exploded), and elevated default risk in commercial and industrial (C&I) lending. So, in our opinion, the current banking environment presents even greater risks than what we have seen during the 2008 GFC.
Almost all the banks that we have recommended to our clients are community banks, which do not have any of the issues we have been outlining over the last several years. Of course, we're not saying that all community banks are good. There are a lot of small community banks that are much weaker than larger banks. That’s why it's absolutely imperative to engage in a thorough due diligence to find a safer bank for your hard-earned money. And what we have found is that there are still some very solid and safe community banks with conservative business models.
So, I want to take this opportunity to remind you that we have reviewed many larger banks in our public articles. But I must warn you: The substance of that analysis is not looking too good for the future of the larger banks in the United States, and you can read about them in the prior articles we have written.
Moreover, if you believe that the banking issues have been addressed, I think that New York Community Bank is reminding us that we have likely only seen the tip of the iceberg. We were also able to identify the exact reasons in a public article which caused SVB to fail. And I can assure you that they have not been resolved. It's now only a matter of time before the rest of the market begins to take notice. By then, it will likely be too late for many bank deposit holders.
At the end of the day, we're speaking of protecting your hard-earned money. Therefore, it behooves you to engage in due diligence regarding the banks which currently house your money.
You have a responsibility to yourself and your family to make sure your money resides in only the safest of institutions. And if you're relying on the FDIC, I suggest you read our prior articles, which outline why such reliance will not be as prudent as you may believe in the coming years, with one of the main reasons being the banking industry’s desired move towards bail-ins. (And, if you do not know what a bail-in is, I suggest you read our prior articles.)
It's time for you to do a deep dive on the banks that house your hard-earned money in order to determine whether your bank is truly solid or not. You can feel free to review our due diligence methodology here.
