FDIC Reports Analyze Growth of Nonbank Lending in US

Bank and Non-bank Lending Over the Past 70 Years

Since the 1970s, the share of bank loans fell as non-banks gained market share in residential mortgage and corporate lending, the report concludes. In other business lines, shifts in loan holdings from banks to non-banks was less pronounced as banks and non-banks continue to play important roles in lending for commercial real estate, agricultural loans, and consumer credit. Banks have regained market share of commercial real estate mortgages after a decline during the financial crisis, with the bank share of commercial mortgages being relatively steady at about 50% to 55% since the mid-1970s. In second quarter 2019, banks held 59% of commercial mortgages. In contrast, the bank share of multifamily residential mortgages decreased substantially between 1990 and 2012 and has modestly recovered since. The report highlights that the primary cause of the shift in loan origination from banks to non-banks is securitization. If less-regulated financial institutions play a larger role in lending, the shift may alter underwriting standards when loan demand increases. FDIC is also expected to publish a series of articles that look closely at the factors driving these trends and the related risks of residential mortgages and corporate debt and leveraged lending.

Leveraged Lending and Corporate Borrowing

The analysis examines the shift in corporate borrowing to capital markets over the past several decades. It also details the ways corporate debt has grown, the resulting risks this shift poses to banks since the 2008 financial crisis, and what factors could mitigate those risks. The report also discusses corporate bonds, including the role of banks in these markets and developing risks. It also details the macroeconomic risks banks face from corporate debt as well as potential risk-mitigating factors. The report finds that the shift from bank financing to capital market financing through bonds and leveraged loans could have implications for banking system stability. The shift may reduce banking risk, because when corporations rely less on direct bank loans, direct bank exposure to corporate borrower credit risk is reduced. However, banks are still vulnerable to corporate debt distress during an economic downturn in several ways:

• Higher corporate leverage built up through capital markets could reduce the ability of corporate borrowers to pay bank and nonbank debt in times of distress.
• Banks lend to nonbank financial firms that in turn lend to corporations, so if corporations default on loans from nonbank financial firms, then nonbank financial firms may default on loans from banks.
• In a downturn, bond issuances and leveraged loan syndications could decline, and any income that a bank had been earning from organizing bond issuances and leveraged loan syndications would be likely to decline.
• The migration of lending activity away from the regulated banking sector has increased competition for loans and facilitated looser underwriting standards and risky lending practices that could expose the financial system to new risks.
• Any macroeconomic effects of corporate debt distress could affect the ability of small businesses, which borrow more heavily from banks, to service their debt. 

Trends in Mortgage Origination and Servicing

The report highlights that, post the 2007 financial crisis, mortgage market changed notably, with a substantive share of mortgage origination and servicing and some of the risk associated with these activities migrating outside of the banking system. Some risk remains with banks or could be transmitted to banks through other channels, including bank lending to non-bank mortgage lenders and servicers. Changing mortgage market dynamics and new risks and uncertainties warrant investigation of potential implications for systemic risk.

The characteristics of non-banks that have, in part, enabled them to gain a competitive edge in mortgage origination and servicing include continued reliance on short-term credit, a focus in conventional conforming and government (Federal Housing Administration or FHA in particular) loan origination, origination of loans exhibiting incrementally eased underwriting standards, application of technological innovation to improve efficiency and origination profits, and less comprehensive regulatory oversight relative to banks. Many nonbank characteristics subject these entities to several risks and the new competitive pressures facilitated by nonbanks have increased several risks in the financial system. These risks include the following:

• Liquidity and funding risks of the nonbank structure
• Interest rate risk inherent in refinancing-focused lending
• Risk of reduced availability of FHA-insured and other government loans in the case of widespread nonbank failures
• Moderate growth in credit risk caused by heightened competition in the market, driving incremental easing in historically tight credit standards
• Cyber-security and other risks related to increased reliance on technology
• Risks posed by the less stringent and more fragmented regulation of nonbanks relative to banks

Related Links

• Press Release
• Report on Bank and Nonbank Lending (PDF) 
• Report on Leveraged Lending (PDF)
• Report on Mortgage Origination and Servicing (PDF)
• FDIC Quarterly

Keywords: Americas, US, Banking, Securities, Insurance, Leveraged Lending, Credit Risk, Securitization, Mortgage Lending, Mortgage Origination, FDIC Quarterly, Commercial Real Estate, FDIC