Britain’s shadow banking sector is more than twice the size of any other economy’s as a share of GDP, according to the International Monetary Fund.
But despite its large size in the UK, it is in the US that lending outside the regulated banks poses the biggest risk, the Washington based fund said. This was partly because the US is the only country where shadow banking assets are greater than those of the conventional banks.
The IMF said in its biannual review of global financial stability: “The US shadow banking system appears to contribute most to domestic systemic risk; its contribution is much less pronounced in the euro area and the United Kingdom.”
The sector, which describes lending via institutions such as hedge funds, property funds and private equity, and through derivatives, grew rapidly in the run up to the financial crisis, and was partly blamed for the freezing of credit markets in 2007.
The IMF’s conclusion was based on staff research, which found that at the end of 2013, shadow banking accounted for around 30% of systemic risk in the US, the same proportion as its banking sector. It was less in the UK and eurozone – 7% and 13% respectively – where the banking sector poses a greater systemic risk because of its size.
The IMF said that since 2012 in the UK, insurance companies have become the largest contributor to the banking sector’s vulnerability to crisis, partly because insurance companies are lending more to businesses.
Evidence suggested that shadow banking activities are picking up in the UK, US and eurozone, partly driven by tighter regulation of regular banks, as well as by low interest rates. Securitisations have declined, but less risky shadow banking activities such as those by investment funds have expanded rapidly.
The IMF said the sector was likely to grow further, partly as it takes on a bigger role in lending to companies.
“Overall, shadow banking is set to grow further in the current environment of tighter bank regulations and low interest rates. Many indications point to the migration of some activities – such as lending to firms – from traditional banking to the non-bank sector.”
Part of the recent rise in the sector in the UK could be explained by growth in peer-to-peer online lending to households and small businesses, the IMF said.
“So far, the … contribution of shadow banking to systemic risk in the financial system is substantial in the US but remains modest in the United Kingdom and the euro area. In the US, the risk contributions of shadow banking activities have been rising, but remain slightly below pre-crisis levels.”
The IMF said shadow banking growth in emerging markets was also rising, notably in China.
“In emerging market economies, the growth of shadow banking size and activities in China stands out and warrants particular monitoring,” the fund said.
