Non-Bank Lending During Crises

Julio Prado, Business Analyst at Wiserfunding, provides a summary of the recently published BIS research, highlighting two fundamental findings.

The regulatory changes imposed post-2008/09 Great Financial Crisis on traditional banks, have allowed non-bank lenders to rise in the financial market. Notwithstanding, the recent rise of non-bank lenders has meant that overall, there is limited understanding of the global behaviour of these during periods of economic downturn. However, a recent paper by published by BIS has shed light on this issue. BIS research provides two fundamental findings: firstly, they find that during a period of economic crisis, non-bank lenders curtail their lending significantly more than traditional banks. Secondly, findings suggest the reduction in lending is amplified as a result of non-bank lenders moving away from relationship-based lending and towards transaction-based lending.

According to the BIS research, there are several factors that contribute to non-banks curbing their lending during crises. Firstly, BIS research shows that overall, non-banks lend to riskier borrowers. BIS finds that their specialization in lending leads to superior knowledge about the borrowers credit quality. In turn, this enables non-banks to lend to riskier borrowers with weaker credit demands. Secondly, BIS finds a crucial distinction in the lending models used by banks and non-banks. Their research suggests that non-banks focus more on wholesale funding, whereas traditional banks rely more on retail deposits. As such, BIS argues that given the reliance and the price sensitivity of wholesale lending, non-banks are more sensitive to the financial cycle, thus increasing their need to reduce lending. Overall, the results show that even though lending for non-banks and banks follow a similar level of volume, these significantly diverge once crises start, with non-banks reducing lending significantly more than normal banks.

The second finding of the research, suggests that relationships between lenders and borrowers from a non-bank standpoint have no significant impact on the approval or rejection of loans. This is especially true during crises. On the other hand, BIS finds that relationships do have a material impact on loan approvals during crises for traditional banks. These results again highlight the difference in the lending approaches between banks and non-banks. As previously noted, banks rely more on relationship lending whereas non-banks use more transactional lending. Even though BIS argues that relationship lending can be useful when information asymmetries are present, it could be argued that transactional lending can provide a more insightful approach. The fact that non-banks can take on additional risk by lending to riskier companies without the robustness of banks, might indicate that transactional lending can provide more secure lending than relationship lending.

Overall, the BIS research sheds light on the heightened sensitivity of non-banks to crises. Their propensity to depend on transactional lending and the higher level of overall risk assumed might be what contributes to their limitation of lending during periods of economic downturn. As a result of this, non-bank lenders can make economic downturns more pro-cyclical, thus worsening the perceived impact.