Worried About Shadow Banking? Don’t Look at China

When we talk about shadow banking, we think of China, one of the world’s most indebted nations. Lending by companies that do not own a banking license has reached 50 trillion yuan ($7.3 trillion), or about 42% of gross domestic product, according to Moody’s Investors Service.

As the recent banking crisis is forcing investors to figure out where the next pressure point might be, they are starting to see that the US has quietly built up a huge pile of hidden debt as well. After a decade of a risk-on run, the US leveraged finance market — almost held entirely by shadow lenders which typically operate with little or no regulator oversight — has topped $3 trillion. Money managers are worried, and even the slow-moving government has signaled closer scrutiny.

At first glance, it’s perhaps good news that banks have become less exposed to corporate America. Since the global financial crisis, corporate borrowing has shifted away from the traditional lenders — which are subject to stricter regulations — towards institutional and retail clients. Banks’ market share has fallen from more than 50% at the turn of the century to just 37% in 2021, according to Moody’s.

This is especially the case in the $1.3 trillion leveraged loan market, which caters to riskier companies and private equity’s buyout activities. Banks still arrange many of these loans, provide information to investors and put together a group of buyers. However, they often don’t end up holding the debt — or at least try not to.

But the recent demise of SVB Financial Group is raising questions of how much lending banks have given to shadow financiers. Consider, the largest portion of Silicon Valley Bank’s $74 billion loan book consisted of so-called subscription lines given to private equity, a typical nonbank lender. This kind of credit is especially useful when money is tight — they give private funds the flexibility to complete deals without having to go to their investors each time they need cash. But they are also hard to offload, in part because they are not assessed by major credit ratings agencies.