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How Does Bank Lending To Non-Banks Affect Credit Allocation And Systemic Risk?

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Using loan-level administrative data and a regulatory shock that induced some banks to redirect lending from non-financial firms to Non-Bank Financial Institutions (NBFIs), Abhishek Bhardwaj suggests firms dependent on such banks witness a contraction in total borrowing and experience worse real outcomes.

Image courtesy of interviewee. November 22, 2024

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The speaker discusses a paper that examines the growing trend of banks lending significant amounts of credit—over a trillion dollars in the U.S.—to non-bank financial institutions (NBFIs) instead of directly to corporations. This video shift raises concerns about credit allocation and systemic risk, particularly as lending patterns affect which businesses receive funding. Larger, safer corporations are losing access to credit, which is being redirected to smaller, riskier firms, potentially reducing economic activity.

The interconnectedness of banks and non-banks means that financial stress in the non-bank sector can adversely impact banks and the wider economy, creating contagion risks. The paper evaluates the policy implications of regulatory disparities between banks and non-banks, suggesting that more transparency and oversight are needed to mitigate these risks. It emphasizes the need for a balanced regulatory approach as both sectors increasingly interact, highlighting the importance of understanding their exposures and potential impacts on credit availability in the economy.

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Here are five key points summarizing the video:

1. **Increased Bank Credit to Non-Banking Financial Institutions (NBFIs)**: There has been a significant rise in bank credit flowing into the non-banking sector, particularly highlighted by the fact that in the US, bank lending to NBFIs has exceeded one trillion dollars. This trend is not limited to the US but is also notable in Europe and emerging economies.

2. **Impact on Credit Allocation**: The paper indicates that as banks shift their credit from larger, older, and safer corporates to smaller, younger, and riskier borrowers associated with non-banks, this affects the overall credit availability for certain corporates, ultimately leading to a reduction in their capital investments and real economic activity.

3. **Systemic Risk Implications**: The interconnectedness of banks and non-banks poses systemic risks, as financial stress in the non-banking sector, which is less regulated than banks, can have contagion effects on banks and the broader economy, leading to a reduction in credit availability.

4. **Regulatory Effects on Lending Decisions**: The paper discusses how regulatory changes, such as modifications in risk weights for non-banks, influence banks' lending strategies. Banks might increase their credit to non-banks, detracting from their credit to corporate borrowers, particularly if they had no prior exposure to non-banks.

5. **Policy Recommendations**: The findings suggest the need for greater transparency in the linkages between banks and non-banks to better understand their exposures. Additionally, there is a call for reevaluating the regulatory framework for banks and non-banks to address the disparities and potential risks arising from the current regulatory landscape, ensuring both sectors are adequately supervised.

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Here are some key quotes extracted from the video , highlighting the main themes and findings:

1. **Introduction to the Convideo**:
- "Is paper is set up any backdrop of increased and large amount of bank credit that is flowing into the non-banking sector."

2. **Significant Findings on Lending**:
- "What we find is that when banks take credit away from corporates and give it to non-banks, the money is taken away from larger, older, and safer corporates."

3. **Impact on Economic Activity**:
- "There is overall reduction in their borrowing, and there is overall reduction in their real economic activity, if you look at it in terms of their capital investments."

4. **Credit Allocation Shift**:
- "The non-banks who get this bank credit actually give out loans to their own set of borrowers, and those set of borrowers happen to be smaller, younger, and riskier borrowers."

5. **Systemic Risk Consideration**:
- "What we find is...one non-bank failing...translates into less credit to corporates, and less credit to non-banks that have nothing to do with the real estate sector."

6. **Regulatory Effects on Lending**:
- "When the risk weights were lowered on these non-banks, banks give more credit to these non-banks."

7. **Income and Substitution Effects**:
- "When the risk weights go down, there is a positive income effect...those banks...lend more to corporate. But...credit is coming away from their corporate borrowers."

8. **Negative Outcomes for Corporates**:
- "If you are dealing with a bank who responds to this policy change and takes credit away from you to their non-bank borrowers, then you as a corporate suffer from lack of credit."

9. **Contagion Risk**:
- "If you have a bank that is very well connected with other non-banks, then you are very exposed to stresses that may affect those non-banks."

10. **Policy Implications**:
- "We believe that the linkages between banks and non-banks should be made more transparent so that we understand what is the real exposure of banks."

11. **Need for Regulatory Oversight**:
- "There needs to be more oversight and more thinking about how to sort of fix this regulatory situation where banks are being increasingly embedded in relatively opaque non-bank sector."

These quotes encapsulate the core elements of the argument presented in the paper regarding the dynamics between banks and non-bank financial intermediaries and their implications for credit allocation and systemic risk in the economy.

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Here are a few articles that are similar in topic and convideo to the video you , which discusses the implications of bank credit flowing into non-banking financial institutions (NBFIs) and the systemic risks associated with this trend:

1. **"The Rise of Non-Bank Financial Intermediation: Implications for Financial Stability"** - This article explores how the growth of non-bank entities has influenced credit distribution and financial stability, addressing potential risks that arise when banks increase their exposure to these intermediaries.

2. **"Banking on Non-Banks: Assessing the Impact on Corporate Lending and Economic Growth"** - This piece analyzes the shifting dynamics in lending patterns as banks divert credit from traditional corporate borrowers to non-banking financial institutions and the consequences for economic activities and investment.

3. **"Contagion Risk: The Interconnectedness of Banks and Non-Banks in Financial Markets"** - This article delves into the systemic risks posed by interconnectedness between banks and NBFIs, especially in scenarios where non-banks face financial distress, and how this affects overall credit availability in the economy.

4. **"Regulating the Non-Banking Sector: A Comparative Analysis of Global Approaches"** - This article discusses different regulatory frameworks for banks and NBFIs across various jurisdictions, highlighting the challenges and discussions surrounding effective oversight to mitigate systemic risk.

5. **"Credit Allocation and Economic Outcomes: The Effect of Bank Lending Practices"** - This study examines how banks' decisions to allocate credit to different borrower categories—larger vs. smaller firms—affect overall economic performance and the potential implications for corporate health.

6. **"The Shadow Banking System: Risks and Regulatory Responses"** - This article reviews the role of the shadow banking system in the broader financial architecture, discussing the risks it poses to traditional banking and the economy at large, along with relevant policy recommendations.

7. **"Linking Non-Bank Financial Institutions and Financial Stability: Insights from Recent Crises"** - This analysis focuses on case studies from recent financial crises to illustrate how non-bank financial institutions can impact financial stability and the importance of transparency in mitigating such risks.

These articles should provide a comprehensive overview of the current discussions and findings related to bank lending practices, the role of non-banking financial institutions, and the associated systemic risks in the financial system.

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Is paper is set up any backdrop of increased

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and large amount of bank credit

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that is flowing into the non-banking sector.

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To give you one example, in the US banks lending to

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NBFIs have recently crossed a trillion dollars.

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And it's important issue not just in the us it's an

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important issue in Europe.

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It's an important issue around the emerging economies.

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And the reason it's interesting and important is

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because banks are supposed

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to specialize in lending to companies.

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But what they are doing increasingly is instead

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of lending directly to corporates, they're lending to these

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non-bank financial intermediaries

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who are in turn making their own lending decisions.

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And so the natural question that comes out of it is

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that obviously banks

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and non-banks have different specializations,

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so this can affect who gets credit in the economy,

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and who gets to use that credit.

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That's the first question we ask.

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Uh, but the second related

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and very important question from a policy perspective is

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banks and non-banks are interconnected.

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And so what might happen is any stresses

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that affect the non-bank sector, which mind you is not

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as tightly regulated as the banks,

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can actually have a contagion effect on the banks

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and the broader economy.

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That's the systemic risk implication that we also look at.

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So that's the, the broader context, of our paper.

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Uh, and, we find some, some expected

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and some very unexpected

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and interesting findings in the paper.

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There are two parts of the paper.

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Uh, when we first look at who gets credit

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to the credit allocation, what we find is that when banks

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take credit away from corporates

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and give it to non-banks,

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the money is taken away from larger, older,

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and safer corporates.

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Uh, these corporates who get credit taken away from them

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suffer in that they're not able

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to get loans from other banks.

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They're not able to get loans from non-banks.

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And so there is overall reduction in their borrowing,

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and there is overall reduction in their real economic

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activity, if you look at it in terms

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of their capital investments, et cetera, et cetera.

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So those corporates are suffering, who's benefiting?

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We find that these non-banks who get this bank credit,

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they actually give out loans to their own set of borrowers,

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and those set of borrowers happen to be smaller, younger,

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and riskier companies.

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And so that's the credit allocation that's taking place,

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which is money is going away from larger, older

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and risk, safer borrowers to smaller, younger,

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and riskier borrowers.

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Now, how does it affect systemic risk?

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What we find is, we use this, large,

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failure or, or a

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Failure of a large non-bank institution in India,

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which focused on infrastructure

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and real estate loans to show that banks that were exposed

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to this failed non-bank basically froze credit

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to not just unrelated corporates,

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but also unrelated non-bank financial institutions.

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And so one, non-bank failing

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because their real estate loans didn't perform well then

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basically translates into less credit to

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corporates,

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and less credit to, non-banks that have nothing to do

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with the real estate sector.

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And so there is an overall reduction in credit

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availability in the economy.

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What happened is in 2009, the Central Bank of India,

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lowered the risk rates that are used

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for capital regulations on certain type of non-banks,

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particularly non-banks

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that have a size greater than 1 trillion Indian rupees.

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And since banks care a lot about the risk weights when they

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make their lending decisions,

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when the risk weights were lowered on these non-banks,

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banks give more credit to these non-banks.

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Now the question is, where is this extra money coming from?

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Well, we find that if a bank already had a lot

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of exposure to non-banks

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and risk rates go down, there is a positive income effect.

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You just have more capital now.

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And so these banks lend more to non-banks.

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They also lend more to corporate.

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But there is other, there is another set

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of banks which did not have any exposure

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to non-banks ex ante.

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And so if they want to lend more to, these banks,

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as in these non-banks,

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the credit is coming away from their corporate borrowers.

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And so, basically it's these banks

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that are basically tilting their portfolio towards,

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non-banks away from corporates.

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So that was the policy change

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and that's how it affected, the lending decisions,

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of banks through the income effect

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and the substitution effect.

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We focus on two, negative,

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effects on unrelated corporates.

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The first is if you are dealing with a bank who responds

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to this policy change

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and takes credit away from you to their non-bank borrowers,

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then you as a corporate suffers from lack of credit.

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We call this a substitution risk.

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Your bank substitutes away from you towards their

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non-bank borrowers.

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The second is the contagion risk, which is now,

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if you have a bank that is very well connected

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with other non-banks, then you are very exposed to stresses

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that may affect those non-banks

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because your bank would be affected if those non-banks fail.

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And then you would suffer lack of credit.

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You, and we also show that it's not just lack of credit,

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you also suffer negative real outcomes in terms

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of economic activity.

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So two risk, the,

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Uh, substitution risk and the contagion risk.

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There are some very important policy implications here.

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The first one is what, policy makers

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around the globe are already talking about,

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which is we believe that the linkages between banks

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and non-banks should be made more transparent so that

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we understand, what is the real exposure of banks.

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Uh, so I think that's the number one policy implication.

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The other is there is still a lot of disparity in terms of

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how banks are regulated versus how non-banks are regulated.

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Uh, and we don't make a strong statement about

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how should we regulate these two entities.

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Uh, should they be regulated differently

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or should they be regulated similarly if

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they're performing the same activity.

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But what we are saying is that there needs

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to be more oversight

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and more thinking about how to sort of

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fix this regulatory situation where we are in,

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where banks are being increasingly embedded in relatively

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opaque non-bank sector,

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which can increase risk for the economy.

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The linkages being more transparent

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is something that would benefit.

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The second one is, I think it's, how to regulate the,

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their lending decisions

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and how to regulate these institutions themselves.

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Apart from the disclosure, I think that's something

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that we have to think hard about.

Bank Lending Dynamics and Systemic Risk in Non-Banking Sector

00:00:00 - Is paper is set up any backdrop of increased and large amount of bank credit that is flowing into the non-banking sector. To give you one example, in the US banks lending to NBFIs have recently crossed a trillion dollars. And it's important issue not just in the us it's an important issue in Europe. It's an important issue around the emerging economies. And the reason it's interesting and important is because banks are supposed to specialize in lending to companies.

00:00:35 - of lending directly to corporates, they're lending to these non-bank financial intermediaries who are in turn making their own lending decisions. And so the natural question that comes out of it is that obviously banks and non-banks have different specializations, so this can affect who gets credit in the economy, and who gets to use that credit. That's the first question we ask. but the second related

00:01:07 - banks and non-banks are interconnected. And so what might happen is any stresses that affect the non-bank sector, which mind you is not as tightly regulated as the banks, can actually have a contagion effect on the banks and the broader economy. That's the systemic risk implication that we also look at. So that's the, the broader context, of our paper. and, we find some, some expected

Shifts in Credit Allocation: Impact on Corporates and Systemic Risk

00:01:37 - and interesting findings in the paper. There are two parts of the paper. when we first look at who gets credit to the credit allocation, what we find is that when banks take credit away from corporates and give it to non-banks, the money is taken away from larger, older, and safer corporates. these corporates who get credit taken away from them suffer in that they're not able

00:02:08 - They're not able to get loans from non-banks. And so there is overall reduction in their borrowing, and there is overall reduction in their real economic activity, if you look at it in terms of their capital investments, et cetera, et cetera. So those corporates are suffering, who's benefiting? We find that these non-banks who get this bank credit, they actually give out loans to their own set of borrowers, and those set of borrowers happen to be smaller, younger,

00:02:39 - And so that's the credit allocation that's taking place, which is money is going away from larger, older and risk, safer borrowers to smaller, younger, and riskier borrowers. Now, how does it affect systemic risk? What we find is, we use this, large, failure or, or a Failure of a large non-bank institution in India, which focused on infrastructure and real estate loans to show that banks that were exposed to this failed non-bank basically froze credit

Impact of Non-Bank Failures on Credit Availability

00:03:14 - but also unrelated non-bank financial institutions. And so one, non-bank failing because their real estate loans didn't perform well then basically translates into less credit to corporates, and less credit to, non-banks that have nothing to do with the real estate sector. And so there is an overall reduction in credit availability in the economy. What happened is in 2009, the Central Bank of India,

00:03:47 - for capital regulations on certain type of non-banks, particularly non-banks that have a size greater than 1 trillion Indian rupees. And since banks care a lot about the risk weights when they make their lending decisions, when the risk weights were lowered on these non-banks, banks give more credit to these non-banks. Now the question is, where is this extra money coming from? Well, we find that if a bank already had a lot

00:04:21 - and risk rates go down, there is a positive income effect. You just have more capital now. And so these banks lend more to non-banks. They also lend more to corporate. But there is other, there is another set of banks which did not have any exposure to non-banks ex ante. And so if they want to lend more to, these banks, as in these non-banks, the credit is coming away from their corporate borrowers. And so, basically it's these banks that are basically tilting their portfolio towards,

Impact of Policy Change on Bank Lending and Corporate Credit Risks

00:04:53 - So that was the policy change and that's how it affected, the lending decisions, of banks through the income effect and the substitution effect. We focus on two, negative, effects on unrelated corporates. The first is if you are dealing with a bank who responds to this policy change and takes credit away from you to their non-bank borrowers, then you as a corporate suffers from lack of credit.

00:05:23 - Your bank substitutes away from you towards their non-bank borrowers. The second is the contagion risk, which is now, if you have a bank that is very well connected with other non-banks, then you are very exposed to stresses that may affect those non-banks because your bank would be affected if those non-banks fail. And then you would suffer lack of credit. You, and we also show that it's not just lack of credit, you also suffer negative real outcomes in terms

00:05:55 - So two risk, the, substitution risk and the contagion risk. There are some very important policy implications here. The first one is what, policy makers around the globe are already talking about, which is we believe that the linkages between banks and non-banks should be made more transparent so that we understand, what is the real exposure of banks. so I think that's the number one policy implication. The other is there is still a lot of disparity in terms of

Regulating Banks and Non-Banks: A Call for Oversight

00:06:30 - and we don't make a strong statement about how should we regulate these two entities. should they be regulated differently or should they be regulated similarly if they're performing the same activity. But what we are saying is that there needs to be more oversight and more thinking about how to sort of fix this regulatory situation where we are in, where banks are being increasingly embedded in relatively opaque non-bank sector, which can increase risk for the economy.

00:07:16 - is something that would benefit. The second one is, I think it's, how to regulate the, their lending decisions and how to regulate these institutions themselves. Apart from the disclosure, I think that's something that we have to think hard about.

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