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What do you call a company where you can deposit money, the institution lends out that money, you get paid a rate of return, and you can later withdraw some or all of the money? A “bank” is a reasonable answer, but it’s far from the only answer. There is a wide range of non-bank financial institutions–that is, non-bank institutions that share at least some properties of banks–and they are expanding in size.

Viral V. Acharya, Nicola Cetorelli, and Bruce Tuckman have written an essay on “Where DO Bands End and NBFIs Begin?” Acharya used the paper as the basis for a keynote address at the 7th Annual Macroprudential Conference Sveriges Riksbank – De Nederlandsche Bank – Deutsche Bundesbank (August 30-31, 2023). Updated versions of the paper are available at the Sveriges Riksbank website, as well as an an NBER working paper. The paper begins this way:

Non-bank financial intermediaries (NBFIs) have surpassed banks as the largest global financial intermediaries. And yet, most NBFIs continue to be lightly regulated relative to banks for safety and soundness, whether in terms of capital and liquidity requirements, supervisory oversight, or resolution planning. Figure 1a shows, using data from the Financial Stability Board (FSB), that the global financial assets of NBFIs have grown faster than those of banks since 2012, to about $239 trillion and $183 trillion in 2021, respectively. In percentage terms, the share of the NBFI sector has grown from about 44% in 2012 to about 49% as of 2021, while banks’ share has shrunk from about 45% to about 38% over the same time period.

Figure 1b compares the assets of the NBFI and bank sectors in the United States alone. As in the global data, NBFIs in the United States have accumulated substantially more assets than banks over the period shown. However, the NBFI sector in the United States accounts for a much higher share of financial assets, which was over 60% in 2021. As an aside, this figure shows that NBFI assets fell substantially during the global financial crisis (GFC), as large volumes of special purpose vehicles were unwound, but that the NBFI sector as a whole subsequently resumed its steady growth.

The category of non-bank financial institutions include a range of entities: firms that issue asset-backed securities, broker-dealers, certain real estate investment trusts, government-sponsored enterprises and agencies, insurance companies, money market funds, mutual funds, pension funds, and other financial businesses.

The challenge posed by the authors is that these kinds of companies are often interwoven with actual banks. However, banks are subject to reasonably tight regulation, especially in the aftermath of the global financial crisis of 2007-08. Thus, these companies are often designed and operate in a way where the nonbank firm takes risks that would not be available to banks, while still maintaining connections to banks that allow them to take advantage of what banks can do in terms of accessing funds or even government safety nets. The bank itself may look safe, but the interconnected web of non-bank and bank institutions may have substantially greater risks. As the authors write:

As a result, the components of [financial] intermediation activities that are under the heaviest burden of bank regulation tend to move from banks to NBFIs, while the components that benefit most from deposit franchises and access to explicit and implicit official backstops tend to remain at banks. It follows, then, that stressed NBFIs are bound to impose systemic externalities, whether by ceasing to function as significant intermediaries; by defaulting on obligations that destabilize some combination of banks, other intermediaries, or parts of the real economy; by drawing down on bank credit lines; or, by starting fire sales in the course of liquidating assets. Hence, while NBFIs in the current regulatory framework are de jure outside the official safety net, they are de facto inside.

As a concrete example, there’s something called the “Blackstone Private Credit Fund (BCRED), currently one of the largest private credit fund in the world with over $50 billion of assets.” Like the name says, it arranges loans, mostly to companies. However, it also puts together groups of lenders–many of whom turn out to be banks. Or as another example:

PacWest, a regional bank that had been losing deposits in the wake of the regional banking crisis of March 2023, sold $2.3 billion of loans backed by various accounts receivable to Ares Management, which is one of the largest private fund managers in the world. The purchase of these loans, however, was financed in part by Barclays. Hence, while the loans seemingly left the banking system through their sale from PacWest to Ares, some of the exposure to these same loans returned to the banking system through the financing of Ares’ purchase by Barclays.

There are many examples of these kinds of interactions between banks and non-banks, operating though credit lines, dealings in financial derivatives, commitments to be available for back-up funding if needed, and more. Exactly how the banking regulators should be taking non-bank financial institutions into account is very much up for discussion. It was a main issue left essentially unaddressed by the Dodd-Frank financial reform law (officially the Wall Street Reform and Consumer Protection Act of 2010), and it remains mostly unaddressed more than a decade later.

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