The EconomistJuly 25th 2020 Finance & economics 552
1You can trace the gradual rise of Ameri-
ca’s capital markets to the 1940s and 1950s,
when the pots of money raised by finan-
ciers such as mutual-fund managers began
to swell. The 1980s brought about a rush of
debt issuance, especially of junk bonds, by
companies. And there was a boom in
household debt winding up in capital mar-
kets—and therefore in the hands of inves-
tors—via the new financial technology of
securitisation, or bundling loans into
bonds and selling them. Eventually securi-
tisation helped cause the crash of 2007-09.
The crisis showed that banks remained
at the centre of the financial system, acting
as dealers and speculators. Subsequent
rule changes have nudged them from the
limelight. Legislation, including the Dodd-
Frank Act in America in 2010, and national
and international regulation, such as the
Basel framework, have together required
banks to fund themselves with more capi-
tal, and encouraged them to take less risk.
As a result, banks in America have nearly
$2trn worth of core capital on their bal-
ance-sheets, almost double the amount
they did in 2007. That is a meaty 12% of risk-
adjusted assets. And crucially, banks’ as-
sets are less troublesome. The risk weight
that supervisors attach to them—a mea-
sure of how racy the underlying loans and
securities are—has dropped from 70% to
less than 60% (these figures adjust for
changes in the regulators’ definition of risk
over that time).
Many of these rules have been aimed at
taming the investment-banking activities
that sit inside huge firms such as Bank of
America and JPMorgan Chase. As all types
of banks have faced tighter regulation, the
last two big standalone investment banks,
Goldman Sachs and Morgan Stanley, have
evolved to look like banking conglomer-
ates, too. Both have spread into sedate ar-
eas that attract more deposits, such as
wealth management and retail banking.
Regulation has blunted banks’ compet-
itive advantage. The fact that they were ver-
tically integrated—they tended to issue
loans, monitor and collect those loans, and
hold the associated risk on their balance-
sheets—once gave them an edge over in-
vestors and funds seeking to profit from
just one slice of a transaction. It made up
for the fact that they were slow to embrace
technology. But bankers now talk of their
balance-sheets as a “scarce” resource.
As banks have grown risk-averse, non-
banks, often tech-savvy, are stepping up.
“When you regulate the banks and you
leave the rest of the financial system more
lightly regulated, there will be regulatory
arbitrage,” says Richard Berner of New York
University. “But technology has also facili-
tated a shift because, particularly in the
past decade, it has promoted the growth of
payments and of bank-like activities out-
side the banking system.”You can gauge this by looking at how the
stock of lending by banks and non-banks
has slowly changed. America has delever-
aged since the financial crisis (see chart 2).
That was almost wholly driven by the de-
cline in mortgage debt, held by both banks
and non-banks. Corporate debt, though,
has reached an all-time high, and the bulk
of activity has still been facilitated by shad-
ow banks. Of the stock of debt that compa-
nies have added since 2012, that lent by
banks has increased by just 2 percentage
points of gdp.The stock that the non-bank
sector holds has risen by 6 percentage
points. Even though banks are now flush
with capital and liquidity it is the capital
markets that have financed the bulk of the
increase in corporate debt.
A notable shift has taken place in the
rest of the world, where capital markets
have historically played a smaller role.
Since the crisis these have expanded. In
2007 global non-bank financial assets
stood at $100trn, equivalent to 172% of gdp
and 46% of total financial assets, according
to the Financial Stability Board (fsb), a
grouping of regulators. Now these assets,
at $183trn, constitute 212% of gdp, or 49%
of the world’s financial assets.
What counts as a shadow bank? In
America banks are now easy to define: they
take retail deposits and are regulated by theFed. They can park cash in accounts with
the central bank, and borrow directly from
it in times of stress. The term shadow bank-
ing, meanwhile, could apply to a range of
financial institutions and activities. It in-
cludes long-established institutions like
pension, insurance, private-equity and
hedge funds, as well as newer ones, like ex-
change-traded fixed-income funds, which
provide a vehicle for savers to deposit cash
that is then invested in government and
corporate bonds.
Separating the activities of the “real”
banks from shadow firms is harder. Some
non-banks, such as private-credit lending
arms, make loans just as banks do. And just
as they did before the financial crisis,
banks issue shadow instruments that are
allocated in capital markets, such as mort-
gage-backed securities or bundled cor-
porate loans. Banks also lend to shadow
banks. This has been one area where bank
lending has grown relative to gdp, and it
now makes up 5% of loan books.What we do in the shadows
Untangling these complex interlinkages is
tricky. But to get an idea of how the finan-
cial landscape is changing in America, sim-
ply look across the range of typical bank ac-
tivities, from the bread-and-butter work of
lending to households and firms, to advi-
sory services and market-making.
Start with mortgages. In 2007 almost
80% of mortgages were created by banks; a
decade later, more than half were originat-
ed by non-banks. Big hitters include Quick-
en Loans, a Michigan-based online lender,
and LoanDepot, a broker in California.
Both were early to online-only mortgage
lending and have invested heavily in slick
websites and responsive call centres.
Quicken, which is preparing to list on the
stockmarket, became the largest originator
of home loans in America in 2018.
Lending to mid-sized firms is also draw-
ing in new types of institutions. The shift is
mirrored by trends in the private-equity
(pe) industry over the past decade or so. pe
used to fund its takeover bids using bank
loans or junk bonds. Most credit funds at
pe shops were in their infancy before the
2007-09 crisis. Today at least a fifth of
funds under management at five of the
largest pefirms—Apollo, Ares, Blackstone,
Carlyle and kkr—are invested in credit as-
sets. At Apollo some $221bn of the $260bn
the firm has raised since 2010 is for credit
investment. The private-credit industry as
a whole has amassed $812bn-worth of cred-
it assets that it manages. To give a sense of
scale, that is equivalent to 14% of outstand-
ing corporate bonds.
Shadow banks are also muscling into
businesses that used to be the sole preserve
of the giant investment banks. That in-
cludes advisory services on mergers and
acquisitions—where newish boutiqueCapital gains
United States, change in total debt
PercentagepointsofGDPSource:
FederalReserve* Excludingmortgages
†UptoQ2 2008 ‡FromQ3 200822012
-192008
-11‡2001
-08†2012
-192008
-11‡2001
-08†BanksMortgages Household* Corporate*30
20
10
0
-1030
20
10
0
-10Non-banksMoving in
United States, mortgageoriginationSource:FDIC3806040200
17102004Marketshare
%Non-banks
Non-banksBanks
Banks1.5
1.2
0.9
0.6
0.3
0
17102004Amount originated
$trn