The Office of the Comptroller of the Currency (OCC), the U.S. regulator that oversees national banks, gave warning today about risky lending. American banks are loosening underwriting standards and taking on extra risk, it seems, extending maturities and offering easier credit terms in the automotive and wider commercial lending markets.
That sounds odd to those of us who have grown accustomed to hearing businessmen complain that the banks won't lend. In Britain and the U.S., conventional banks have become so uncomfortable and bureaucratic about risk that strange new lenders – peer lending websites, crowdfunders and direct-lending fund managers – have appeared and are stepping into the vacant space. And with these competitors giving banks a kicking in their core market, the banks are trying to fight back.
Last week, Santander, a major European bank, struck a deal with Funding Circle, a U.K. Internet platform that arranges peer-to-peer commercial loans. Santander will refer its clients to Funding Circle while the latter will endorse the bank's services. It sounds like harmless marketing but in reality it is a huge admission by a leading bank that its lending model no longer works for small and medium-sized businesses.
In California, a San Francisco lender, Union Bank, has agreed to buy consumer loans through Lending Club, a Web-based lender. Like Santander, the Californian bank sees an easy route to customers, avoiding the bureaucracy and regulation of conventional lending. In London, a new vehicle, P2P Global Investments, was launched on the stock exchange after raising £200-million ($364-million). It will buy loans form peer-to-peer Internet lenders, such as Funding Circle, offering its investors a spread of risk and a target return of 6 per cent, more than three times a typical bank deposit rate.
From exotic startups, alternative lending has quickly matured to the point where it is about to be institutionalized. Yet financial regulators don't know what to do about these new lenders, the shadow banking market, reckoned to be worth some $71-trillion (U.S.) in assets worldwide, according to the Financial Stability Board. The unconventional lenders are exploiting their freedom to lend without the huge asset-backing and solvency requirements of banks.
Some worry that the shadow banking market is a black hole of potential systemic risk, while others see no issue with a form of direct investment that exposes lenders to direct risk outside of the banking system. Either way, it is clear that the market is functioning as it should. Shadow lenders are providing credit to businesses – finance that would not otherwise be available. If central bankers are not getting too excited about the behaviour of the shadow market, it is not because they are sanguine about the risks. More likely, they are aware that their own policy tools, interest rate management and quantitative easing, have largely failed to stimulate lending to the small and medium-sized commercial sector, the traditional drivers of economic recovery.
Consider the continuing confusion about interest rate policy on both sides of the Atlantic. So annoyed were some British MPs at Bank of England Governor Mark Carney's recent contradictory statements about the prospect for rate hikes, that one accused the Governor of behaving like an "unreliable boyfriend," blowing hot and cold. His mixed messages about the future path of interest rates are leaving businesses and consumers none the wiser about a key financial risk.
Meanwhile, others are wondering why the Fed chair remains dovish in the face of rising inflation and financial asset prices. In the U.K., Mr. Carney is slapped almost daily with media stories about the extraordinary escalation in house prices, which have risen in central London by almost a fifth over the past year. Still, no one seems to want to tighten rates because on both sides of the Atlantic, there is a nagging fear that there is still too much spare capacity in the economy, too little investment and weak or nil wage inflation. In short, higher rates are too big a blunderbuss to be used to fine-tune this tentative recovery.
That begs the question – what are lenders doing, and why is the OCC worrying about deteriorating credit quality? The answer is to be found in the shadow banking market, where insurance companies, asset managers and Internet lenders are carving huge chunks from the banks' soft underbelly. If the banks' effort to fight back turns into bad lending and poor credit quality, it could prove to be their final undoing. We can only hope it does not prove the undoing of economic recovery.