In 2008 the collapse of Lehman Brothers was the start of the banking crisis. For those close to it, the issues had been lurking below the surface of the financial world for some time. The secondary banking crisis and the sub-prime mortgage fiasco were all in effect warning quakes for the “big one” to follow. However, even then no one really appreciated just how deep this disaster was going to be.
Other banks were supported either by shareholders or, more drastically, governments bailing them out as they teetered on the edge of collapse. For those of us watching there was fear over just how far this could go and how dangerous was the contagion of bad money poisoning good. There was also a feeling of just desserts for those arrogant and overpaid financial pseudo-aristocrats who had lorded it over their apparent domains. Not only had these people paid themselves astonishing sums of money, but then had the gall to turn to the citizens, through their governments, to bail them out, with little or no personal pain to themselves – for most at any rate. The real pain was felt by the taxpayers, the ordinary shareholders and the greater economy who bore the brunt of this.
In fact at the time of Lehman’s, there was a clear feeling that of all the investment creatures, this particularly slimy one could afford to be let go. However, few of us at the time (although many changed their tune later with rewritten history,) really appreciated how Lehman’s tentacles were in fact far more insidious than its competitors and thus its collapse caused a far greater wider failure than initially expected.
Since then, as we hear regularly, we (the industry and regulators) have learnt from this and understand how such a disaster could be prevented from ever happening again. The trouble is that the next folly will not be the same as the last, and thus learning from past mistakes does not insulate you from future failures. The industry, regulators and politicians will now have to take a broader view to understand the risks and not just take comfort in understanding one single aspect of it, but appreciate how the various elements work together. This is not as straightforward as the operations and the overall set-up has changed dramatically often due to the astonishing developments of technology, but also inevitably owing to the effects of the pandemic.
Today’s issue is not just banking, be it commercial or investment, but rather something far more elusive – and that is the world of “shadow banking”. In essence, shadow banking is the provision of financial services but not through the usual banking outlets and companies. This may not seem to be such an issue until you consider issues such as regulation, compliance and risk management. In effect you now have new beasts on the wild financial savannah, but ones that previously you had not realised might be dangerous. Quite rightly, I will be wary of lions but don’t expect a nasty nibble from a wildebeest.
So what form do these shadowy creatures take and how can we recognise them? Essentially, we have to look at what they do rather than what they claim to be. Recently in the UK, we have had the scandal of a company called Greensills which had grown at phenomenal speed, providing what many headlined as a new form of financing and an improvement in cash flow – surely a god-send for businesses controlling their cash. They would call it “supply chain financing” which in plain English is factoring or discounting invoices, a service which is as old as trade itself, but one which was usually carefully regulated under the providers who were usually banks. The history of this service goes right back to the days of the medieval crusades which would aid the finances of would-be crusaders on their perilous adventures in the Levant.
In this case, the company did provide invoice discount financing but then took it a stage further by discounting even future invoices (i.e. those which as yet do not exist) and then putting these into bonds which could then be sold by real banks (in this Credit Suisse amongst others) which brought it back into mainstream finance, and finally may have ended up as “safe” bond investments in our pension funds! This gave them a respectable appearance. As a result, these funds would certainly now be seen as endorsed by larger well-regulated and apparently responsible institutions.
These then are often traditional financial facilities but provided by the new generation of technology-based companies. Amazon and Google will often be involved in types of mass financial transactions, but are they now banks or should we still call them “tech companies”? In my view, these are transactional businesses using technology for their own benefit rather than just pure technology businesses.
Across Europe, such companies may be offering investment funds and money market funds, and include other financial intermediaries, such as corporations providing leasing, factoring, or hire purchase. This is a very simplified broad definition of shadow banking. As for its scale, in 2018, shadow banking assets in the euro area amounted to almost €34.5 trillion, accounting for more than 40 per cent of the entire financial sector.
What we should all do now, whatever our professional life, is to look at what our business partners are actually doing rather than what they like to title themselves. The old phrase is, “if it walks like a duck and squawks like a duck – then it probably is a duck”. However we should rewrite that to say, “if it looks like an ugly duckling, then it probably is an ugly duckling” – and is unlikely to grow into tomorrow’s white swan.