By Alexander Jones, International Banker
Having experienced rapid growth in recent years through the likes of hedge funds, pension funds, private credit firms, insurance companies and many other types of financial intermediaries, the shadow-lending sector now has regulators around the world ringing the alarm bells over the potentially substantial risks it presents to the global financial system. With the linkages between the sector and the traditional financial sector becoming stronger by the day, moreover, the urgency to assess and, ultimately, contain shadow-lending risk has perhaps never been greater than it is at present.
Authorities have become increasingly vocal about the emerging financial-system vulnerabilities posed by shadow lenders—or, as regulators have termed them, non-bank financial intermediaries (NBFIs), which typically take money from investors and then lend it out to borrowers of varying creditworthiness. Those vulnerabilities include liquidity mismatches, unsustainable leverage and deep interconnectedness between the two systems, all of which are now chief among regulators’ concerns.
What’s more, the sheer scale of the issue is now gargantuan. The Financial Stability Board (FSB), an international body that promotes global financial stability, reported last December that the NBFI sector accounted for roughly $250 trillion in 2023, or 49 percent of global financial assets. With private credit funds having increased their assets under management (AUM) from about $0.2 billion in the early 2000s to over $2.5 trillion today, moreover, it should come as no surprise that much of the regulatory scrutiny is now focussed squarely on this booming industry.
In a March 2025 paper, the Bank for International Settlements (BIS) contended that private credit fills unmet demand for credit in general. “About 10 percent of all small and medium-sized firms in advanced economies and over 20 percent in emerging market economies report being credit constrained, often due to a lack of collateral (Caballero et al. (2025)),” the report noted. “The growth of direct lending by private credit, providing uncollateralised loans with tailored covenants to small and medium-sized firms, could stem from the needs of firms underserved [by] banks.”
Today, private credit investments account for some $2 trillion, according to the International Monetary Fund (IMF), while the Organisation for Economic Co-operation and Development (OECD) has estimated that such funds make up some 12 percent of bank loans to non-financial corporations. In terms of the interconnectedness between banks and NBFIs, therefore, the two sectors are becoming inextricably linked, with private credit and an additionally broad range of financial activities making them only more mutually dependent.
“Banks provide leverage, clearing, market-making and underwriting services to NBFIs, trade derivatives with NBFIs and, in some cases, own NBFIs,” according to a “horizon-scanning” in a July 10 report from the Basel Committee on Banking Supervision (BCBS). “These activities expose banks to a wide variety of risks. NBFIs are also exposed to banks through short-term cash placements, investment in securities issued by banks and trading activities. The nature of their linkages is shaped by market conditions and by regulatory reforms over the last several years.”
Such vulnerabilities can become exposed during stress episodes and create risks to financial stability, the chair of the European Central Bank’s (ECB’s) Supervisory Board, Claudia Buch, recently observed. “The ‘dash for cash’ episode in March 2020 [the rapid, pandemic-induced selloff of securities by global investors in favour of cash], the collapse of the highly leveraged family office Archegos in March 2021 and the UK gilt market crisis in September 2022 are examples of how shocks can be amplified and transmitted across the financial system,” Buch stated in a June 3 article for the ECB’s European Banking Supervision Blog. “What ties these episodes together is a combination of high leverage, vulnerabilities to tight liquidity conditions, and opacity. These are structural features of many NBFI business models, which are often subject to lighter regulation than banks—or fall outside traditional regulatory frameworks altogether.”
Given the global dominance of its own shadow-lending market, the United States is seeing its regulators demonstrate significant concern over the mounting risks stemming from shadow lending. On June 30, the St. Louis Federal Reserve (St. Louis Fed) disclosed that US banks held $1.14 trillion in outstanding loans to the NBFI sector at the end of the first quarter. “This interconnectedness between banks and nonbanks adds an extra layer of intermediation, as banks lend to mortgage companies, insurance companies, investment funds (such as mutual funds, money market funds, hedge funds and private capital funds), pension funds, broker-dealers, securitisation vehicles and other financial entities, which then lend directly to end users in the economy,” the St. Louis Fed noted.
A separate June 25 report from the US government’s public-policy research institute, the Congressional Research Service (CRS), meanwhile, found that not only are banks continuing to lend to NBFIs in increasing amounts, but they are also reducing their lending to commercial and industrial borrowers. “Increased lending from banks to NBFIs could expose banks to counterparty credit risk and spillover effects during a financial crisis…,” the report warned. “The size and growth of NBFI suggest that [a] significant amount of financing is being intermediated and held outside of the banking sector. In contrast to the traditional banking model, where banks normally manage risks (e.g., credit, market, liquidity, and operational risks) on their balance sheets, the market-based NBFI financing model shifts risks toward capital markets investors and intermediaries.”
Regulators are increasingly acknowledging the pressing need to take more concrete measures to both quell the risks from this ballooning universe of shadow entities and boost the resilience of NBFIs. Indeed, the FSB published its own research on July 9, outlining key policy recommendations to address financial-stability risks created by leverage in NBFIs. Titled “Leverage in Nonbank Financial Intermediation”, the report detailed an integrated approach through which authorities should identify financial-stability risks created by NBFI leverage and implement policy measures to address them. The recommendations themselves can be grouped into five distinct categories:
- Risk identification and monitoring: Authorities should have a domestic framework to identify and monitor any financial-stability risks created by NBFI leverage effectively and frequently. They should seek to address data challenges in their domestic risk-identification and monitoring frameworks, mainly through collaboration to jointly reduce hindrances to effective cross-border risk identification and monitoring and to promote better data and information sharing.
Authorities should also review the “granularity, frequency, and timeliness” of existing public disclosures and determine whether additional or enhanced disclosures should be provided to the public to help identify and mitigate financial-stability risks from NBFI leverage.
- NBFI leverage in core financial markets: Authorities should address financial-stability risks from NBFI leverage that they identify in core financial markets and consider those measures that are most appropriate to the risks they identify, including activity- and entity-based measures, as well as concentration-related measures.
They should also consider the adverse effects of specific measures and calibrate policy measures to minimise any unintended consequences.
- Counterparty credit-risk management: Authorities should ensure the timely and thorough implementation of the BCBS’s guidelines on counterparty credit risk (CCR) for bank leverage providers. The guidelines provide a comprehensive policy response to financial-stability risks from NBFI leverage.
They should also review existing counterparty disclosure practices made privately between leveraged non-banks and leverage providers and consider collaborating to develop mechanisms, standards and/or guidelines to enhance the effectiveness of these practices.
- Incongruent regulatory treatments: Authorities should identify instances where an NBFI’s leverage provision is subject to “incongruent regulatory treatments”, which may result in regulatory arbitrage that could increase financial-stability risks. They should determine how to address the identified incongruences, possibly by referring to the treatment of similar situations in other jurisdictions.
- The importance of cross-border cooperation: As and when feasible, authorities should engage proactively with their peers to facilitate coordinated crisis and/or policy responses to financial-stability risks created by NBFI leverage.
Following a debut test by the Bank of England (BoE) last year, the European Union (EU) also announced in late May that it was preparing its first-ever stress test of NBFIs to ascertain the extent and the nature of the risks they pose. According to the Financial Times, the system-wide exercise would examine how a potential market crisis could impact pension funds, insurers and other NBFIs.
“We’ve seen some crisis episodes where liquidity risk spillovers came from the NBFI, non-bank financial intermediation space,” the ECB’s Buch told the European Parliament (EP). “So, it’s important that this is also well understood and well regulated. So not all NBFIs are more risky than banks or other financial institutions, but we need to address the risks there in the right way, and also the regulation needs to be targeted to those risks.”