There used to be an old radio show that asked about the evil that lurked in peoples’ hearts.
“The Shadow knows,” intoned the narrator.
We’ll bend that verbiage a bit – who knows what risks lurk at the fringes of the financial sector?
The shadow banks know.
The banks lending to them might not know, which means that they likely need to step up their know-your-customer and other risk-management efforts.
Shadow banking is a catch-all phrase referring to when traditional firms have lent money to lightly regulated FinTechs and other “non” traditional financial firms. If the FinTechs and other creditors run into trouble and their financials go south, the traditional FIs take a financial hit.
In June, the Federal Reserve Bank of New York said in a blog post that banks and non-banks are “intimately interconnected,” and the latter are dependent on banks for term loans and lines of credit. Overall lending to shadow banks is estimated to exceed $1 trillion as of January. Term loans, which are upfront payments from the lenders that are paid out by the borrowers over time, represented a bit more than a quarter of lending to nonbanks, up from about 15% in 2015, the Fed said.
More recently, the Financial Times noted that First & People’s Bank, a small bank based in Kentucky, has been hit by loans to FinTech US Credit that have not been performing. According to the report, the Kentucky bank, which has roots spanning more than a century, may be at risk for failure.
A separate April report from the National Bureau of Economic Research noted that “case studies and regulatory data show that banks remain exposed to credit and funding risks, which at first glance seem to have moved to NBFIs, and also to contingent liquidity risk from the provision of credit lines to [non-banking financial intermediaries],” such as FinTech lenders.
We’re headed, with certainty, to more oversight. As detailed in the Financial Stability Oversight Council’s November interpretive guidance, which became effective in January, the Council can determine “that a nonbank financial company will be subject to supervision by the Federal Reserve and prudential standards and lists the considerations that the Council must take into account in making such a determination.” These new rules seek to establish a new framework to gain better insight into non-bank risk, where banks lend to hedge funds, mortgage firms and also take on FinTech risk.
The examinations and supervision would take into account the “nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the nonbank financial company could pose a threat to U.S. financial stability.”
For banks, a number of providers and platforms have been introducing know your business (KYB) technologies and solutions that are designed to help gauge risk at the point of onboarding. In one example, Enigma introduced its KYB platform in October. Separately, Israeli identity verification firm AU10TIX in February launched its own KYB products and services.
The oversight would come amid 65% of banks and credit unions entering into at least one FinTech partnership in the past three years, with 76% of banks viewing FinTech partnerships as necessary to meeting customer expectations, according to PYMNTS Intelligence research. These partnerships would include lending, which in turn will likely gain greater scrutiny as to where the risks lie, and how much risk is in the system.
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