Reassessing Systemic Risk in Nonbank Financial Institutions

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url('https://www.aima.org/static/990ed68c-0781-4dcc-94d5101682e06bbd/AdobeStock215796247.jpeg');"> <div class="banner-content"> <div class="cta-container container"> <div class="cta-wrapper"> <a href="https://www.aima.org/compass/insights/private-credit/nonbank-financial-institutions.html#Download" title="Reassessing Systemic Risk in Nonbank Financial Institutions" class="btn btn-red-bordered btn-lg">Download the report</a> </div> </div> <div class="container"> <div class="row"> <div class="col-xs-12"> <div class="banner-content-detail text-center "> <h1 style="color:#ffffff" >Reassessing Systemic Risk in Nonbank Financial Institutions</h1> <p style="color:#ffffff" >A Critical Analysis of Recent NY Federal Reserve Studies from an Alternative Investment Perspective</p> </div> </div> </div> </div> </div> <div class="banner-content-logo"> <div class="container"> <div class="row"> <div class="col-xs-12 col-sm-8"> <ul class="partner-logo"> </ul> </div> <div class="col-sm-4"> <div 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light-typography"> <div class="container"> <h2>Foreword</h2> <div class="row"> <div class="col-xs-12 "> <p>The rapid growth of private credit in the last decade is reshaping the financial ecosystem among asset managers, banks and insurers. The Alternative Credit Council (ACC) has been at the forefront of documenting and analyzing this growth via its decade of Financing the Economy annual surveys and reports.  Recently, however, a spate of news stories and academic studies have questioned whether this impressive growth might result in the buildup of potential systemic risks. At the same time, prudential regulators have also raised concerns about the rapid rise of private credit and other financial institutions that are not banks. </p> <p>Earlier this year, a series of posts appeared on the New York Federal Reserve website that cited a spate of recent academic articles that made several erroneous claims about the relationship between banks and other financial institutions, including private credit. Those papers and the subsequent NY Fed blog posts analyzed new data on banks’ funding of other financial institutions. They used that to argue for significant new supervisory and regulatory controls over all financial institutions, including private credit funds. </p> <p>Since the ACC is uniquely placed to provide insights into the private credit sector, in this paper, we are critiquing what we are collectively calling the NY Fed papers on banks and other financial institutions. This paper explains why private credit and other financial institutions do not threaten financial stability. Contrary to the mistaken claims in the NY Fed papers, private credit funds do not pose systemic risks. With long-term investments, low leverage, and strong liquidity management, they’ve actually proven to be more resilient and better able to lend during crises like the 2007-08 crash and the COVID-19 pandemic.</p> <p>Private credit works alongside banks in a complementary way, not as a form of arbitrage that results in a continuing reliance upon emergency bank lending. Private credit funds are not, in fact, significantly dependent on banks for liquidity. They operate independently, offering safer, diversified lending solutions that complement banks and reduce banks’ risk via secured lending versus direct exposure to the underlying assets.</p> <p>Finally, the regulatory proposals discussed in these papers would hurt the economy. Increased regulation and stress tests for NBFIs are unnecessary and would undermine their positive impact. NBFIs boost credit availability and lower risk for banks, so overregulation would do more harm than good.</p> <p>Overall, the critique makes four key points regarding the NY Fed Papers:</p> <ul> <li>First, it explains how the NY Fed Papers' reliance upon combined data from twelve very different types of NBFIs distorts all subsequent analyses. </li> <li>Second, it points out how the NY Fed Papers fail to take into account private credit's stable funding, low leverage and alternatives to bank funding, which results in inaccurate assessments of the potential for the transmission of risk via the two relevant systemic risk channels of asset fire sales and counterparty credit risk. </li> <li>Third, it explains how bank lending to a private credit fund actually reduces risk to the bank because a bank's senior, secured lending to a private credit firm is significantly safer than direct lending. The financial system as a whole is also safer because private credit funds utilize less leverage, reduce maturity transformation, and have more liquidity risk management tools than banks.</li> <li>Fourth, it describes the flaws in the NY Fed Papers' proposed ex-ante and state-contingent policy proposals, which would damage capital markets and eliminate the benefits and efficiencies that NBFIs provide to the real economy.</li> </ul> </div> </div> </div> </div> <div id="section-methodology" class="featured-section"> <div class="container"> <h2>Download the report</h2> <div class="row"> <div class="col-xs-12 col-md-9"><p><a id="Download" name="Download"></a></p> <div class="cta-widget"> <div class="cta-content bg-grey-light"> <h3 class="cta-heading">Reassessing Systemic Risk in Nonbank Financial Institutions</h3> <p class="cta-text"></p> <p class="cta-text"> <a href="https://www.aima.org/asset/302795E5%2D0378%2D4E30%2DB6E9F54453D00EE3/" title="Reassessing Systemic Risk in Nonbank Financial Institutions" class="btn">Download the report</a> </p> </div> </div> <p>For further information please contact <a aria-label="Link Joe Engelhard" href="/cdn-cgi/l/email-protection#3f555a51585a53575e4d5b7f5e56525e11504d58" id="menur8md" rel="noreferrer noopener" target="_blank" title="mailto:jengelhard@aima.org"><strong>Joe Engelhard</strong></a>, Head of Private Credit and Asset Management Policy, Americas.</p> </div> </div> <div class="row"> <div class="col-xs-12"></div> </div> </div> </div> </section> </div>  <footer id="subhead" class="site-footer"> <div class="partners"> <div class="container"> <div class="row"> <div class="col-xs-12"> <h2 class="u-aligned-center">Sponsoring Partners of AIMA</h2> </div> </div> <div class="row"> <div class="col-xs-12"> <div class="partners-item" style="width: 20%;"> <a href="https://www.aoshearman.com/en" target="_blank"> <img 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Reassessing Systemic Risk in Nonbank Financial Institutions