The place for shadow banking in the economy

The place for Shadow Banking in the economy

The ability to access credit and finance operations influences the decision of which hedge fund, money market fund, private equity fund and other asset-backed financing vehicle you should place your money in.

Shadow Banking is a non-banking entity that provides lending services, such as asset-backed securitisation through special vehicles, outside the traditional regulatory environment in which a traditional bank should operate under. For instance, a company would sell off its debtors to a securitisation vehicle which would then repackage those debtors as bonds, which would then be sold to investors. The company obtains financing while the investors will obtain regular payments as the special purpose vehicle receives interest and capital payments from debtors.

Shadow banking can provide credit to clients more cost efficientlyec as shadow banks do not have to comply with the rigorous regulations enforced upon the traditional banks. This allows the shadow banks to provide credit to the low income market where customers’ credit worthiness might be poor. The approach results in an upside and a possible downside. The upside being that shadow banking lending can boost economic growth as even the low income earners have access to credit in order to continue spending money on goods. However, the downside is that the low income earners may not be aware of the actual cost implications and will realise later that they cannot afford the credit that was provided and will end up in a constant debt cycle.

Shadow banks also provide financing, but at far higher interest rates that the traditional banks and require significant collateral for amounts lent. They are seen as growth initiators as they can provide lending where traditional banks cannot due to regulation.

Asset-backed securitisations through special purpose vehicles were a major part factor in the 2007-2008 financial crisis. As a result of the financial crisis, the government called for tighter regulation over these special purpose vehicles specifically used for debt financing purposes. Countries still struggle with low growth as the traditional banks are still attempting to recapitalise their balance sheet to align with current regulations. Whereas the shadow banks are obliged to register with the National Credit Regulator (NCR) who regulates in terms of The National Credit Act (NCA).

Shadow banking is a far reaching industry which has implications for all lending in South Africa. In terms of consumer market lending, which can be seen as the most risky form of lending in the shadow banking space, regulation is in place and will, more than likely, be strengthened in the future.

David Okwara

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