Shadow banking ‘won’t compensate for lending fall’

The growth in shadow banking across the eurozone will not compensate for the fall off in traditional bank lending as banks continue to deleverage, according to a new report by ratings agency Standard & Poor’s (S&P).

S&P attributes the comparatively low levels of shadow banking finance to a lack of regulation and poor demand for credit, particularly in periphery eurozone countries.

The shadow banking system consists mainly of hedge funds, structured investment vehicles and the securitisation markets.

According to S&P, ongoing bank deleveraging and gradual economic recovery are ideal conditions for growth of the shadow banking system in Western Europe.

“European shadow banking continues to grow, both in terms of the volume and availability of credit intermediation activities,” said Standard & Poor’s credit analyst Dhruv Roy. “However, given the scale and pace of bank deleveraging, we consider it unlikely that the growth of shadow banking in itself will substantially make up for a contraction in banking activity over the medium term.”

When the Government held the EU presidency over the first six months of last year, the Department of Finance put on the agenda alternative forms of financing for SMEs, particularly securitisation models.

However, the lack of demand for credit will pose a near-term barrier to the development of the shadow banking system.

“Even as banks continue to deleverage, not all of the lost lending capacity will need to be replaced straight away as businesses and households continue to repair their finances. Regulatory initiatives to better control and monitor the financial stability risks posed by shadow banking remain at an early stage, which in our view could hamper the sector’s growth,” said Dhruv.

Other obstacles include a lack of market liquidity for certain shadow banking assets; limited institutional investors’ appetite for alternative asset classes; and a paucity of independent benchmarks and information that would help investors better understand these unfamiliar asset classes, said S&P.

Cultural factors, such as borrowers’ reluctance to veer away from long-term banking relationships, are also important aspects, it added.