Shadow banking is often used to describe credit lending carried out by non-banks. The term gained currency during the post-financial crisis period and is loaded with negative connotations about the role of finance during that time. As a result the term is often used as a value-judgement that fails to recognise the benefits of the capital markets and asset management sectors for the real economy.  There is however evidence that attitudes are changing.

Recently, Peter Andrews, Chief Economist at the Financial Conduct Authority chose this sector as the topic of a speech he gave to the financial services industry. He too believed “market-based finance”, or MBF, as opposed to shadow banking was a better description: “MBF is not just about banking in the shadows with a view to benefitting from compensation schemes and bail-outs that are entirely paid for by others,” adding, ”MBF may be more efficient than traditional banking.” More importantly he argued in favour of this relatively untapped source of capital and how this could be translated into beneficial economic activity.

Banks have been forced to retreat from lending as they shored up their balance sheets and many private credit managers have stepped in to fill the gap. Private lending by funds is a growing sector and much needed source of capital. For example, Standard & Poor’s estimates European SMEs will need $3.8tn (€3.5tn) in extra funding by 2018.  As well as providing much needed funding, the sector can solve the problem of scaling up as we can more easily draw from a wider pool of investors. This increased level of competition for capital means risk and capital is allocated more efficiently, at a lower cost that could mean more sustainable growth and stability.

Another valuable point raised by Peter was the ‘spare tyre’ argument, namely that MBF could reduce the impact of economic shocks by providing an alternative source of finance during times when banks are unable or unwilling to lend.  This is not to say that Peter sees no potential risks for the sector’s future. It is however encouraging to hear him say that “one should facilitate and welcome market solutions to market problems wherever they can occur, and consider very carefully whether they really can be bettered”.

Peter Andrews is right when he says that this sector, if monitored carefully, “can generate significant welfare gains for society.” Those who see shadowy risk in what is a fully regulated and transparent industry should lighten up.