By Jealous Chishamba
THE Financial Stability Board which regulates financial markets practice for G20 economies defines shadow banking as lending by institutions other than banks. Universally, these non-bank entities referred to as shadow banks operate outside normal banking regulations.
One reason for the proliferation of these companies is that they want to avoid the stringent regulation associated with banks. Hence, in a way they tend to enjoy the benefits of regulatory arbitrage.
Sometimes, there is a disagreement on what counts as a shadow bank.
For example, it can be defined from the perspective of the entity originating the transaction or the instrument issued itself.
In general, the core determining factor is credit and any bank-like activities undertaken by firms which do not qualify as banks. Thus, this includes unregulated microcredit institutions, hire purchase or lease finance companies and securitisation special purpose vehicles.
There has been a rise in the growth of shadow banks across the global economy.
Over the years, banks have been affected by a myriad of factors such as growing losses, diseconomies of scale, competition, heavy regulation, retrenchments and high capital requirements. When these banks downsized their lending operations, they left unsatisfied demand for credit.
As a result, shadow banks have been capitalising on this vacuum. In 2014, the International Monetary Fund in its third quarter global financial stability report indicated that shadow banking contributes one quarter of total financial intermediation worldwide.
For example, China’s shadow banking, sometimes referred to as dark money, is growing at twice the rate of bank credit and as at March 2014 the growth had reached 35% of GDP. Due to loose ends in China’s financial regulatory environment, the significant growth in shadow banking has made implementation of monetary policy difficult as massive defaults have ensued. Separately, in the USA shadow banking assets exceed those of conventional banking institutions.
There are different schools of thought about the relevance of shadow banks in any given economy. In light of rising defaults, banks have become overly risk averse and shadow banks have emerged as possible economic growth initiators through their complimentary services.
For instance, to access credit, banks have stringent lending requirements which tend to disqualify the low income earners but shadow banks lessen these requirements.
On the downside, shadow banks are not backed by safety nets like the lender of last resort or agencies that intervene in the event of financial trouble. Thus, if left unregulated, they can cause financial crisis. Bank of England governor, Mark Carney, in the first quarter of 2014, noted that shadow banking is the greatest danger to the world economy if not managed well. For example, special purpose vehicles were behind the global financial crisis.
On the consumer market, shadow banks do not check financial literacy for individuals and the consumers may not be aware of the high costs involved.
There are higher interest rates and punitive default costs associated with shadow banks. For example, in South Africa, the level of unsecured debt is extremely high for low income earners.
Considering the rising impact of shadow banks, South Africa implemented the National Credit Act to regulate credit provided to consumers and to also avoid over-indebtedness. While shadow banks provide credit at a time when many banks are incapable of doing so, if these activities are left unaddressed, the inherent risks may compromise global financial stability.
Closer to home, shadow banks include hire purchase, mobile call loans, lending by individuals, group lending schemes and cooperatives. All these activities fall outside the supervision of bank regulators.
In an economy like Zimbabwe where there is generally lower disposable income and a high informal market, shadow banks like cooperative schemes and unregistered group lending arrangements provide easier credit to the lower income market that would have been excluded by banking institutions. For example, Econet is not regulated as a bank but it offers airtime credit to its customers.
With an active subscriber base of almost 8 million customers, Econet can afford to offer US$0,50 airtime loans to any given subscriber with a cost to the customer of 5 cents.
Assuming the customer buys additional prepaid airtime within a day or week after the loan, it translates to 10% flat per day or week. Thus, Econet operates as a shadow bank as this constitutes lending in the consumer banking market.
Companies like Edgars and Truworths also qualify as shadow banks as they operate hire purchase schemes. These companies have been equally affected by defaults.
For an illiquid economy like Zimbabwe, shadow banks provide benefits for the economy.
If anything they encourage individuals to borrow for consumption when in actual fact borrowing should be for capital projects. However, like South Africa, there is need to design regulatory mechanisms which avoid over indebtedness.
While advancing credit to the economy is beneficial for growth, the capacity to repay is also important. For example, currently the financial sector is struggling with a high average non-performing loan ratio of 18,5% which is unhealthy for the economy. If defaults in shadow banks are included, this ratio may be underestimated.
For example, there is a growing level of doubtful provisions in the hire purchase market where Edgars and Truworths operate. Our challenge is lack of monitoring mechanisms and a dysfunctional credit reference bureau to ascertain the quantum of credit in the local economy.
Citing the 2007-2008 financial crises, shadow banking is a powerful tool for economic growth but if carelessly monitored or managed, it can be explosive.