The explanation is simple: in 2008, the American Congress tightened the regulation of the banks, but in exchange, it left these non-banking players out of this framework. This banking regulation was only a swimming pool with three walls, from which the risks escaped to develop outside the banks…
Serious mistake, because those who inherited these risks are very large hedge funds, huge asset management funds like BlackRock, venture capital funds, broker-dealers (stock traders) , off-balance sheet vehicles, money market funds, etc.
Wall Street is worth Las Vegas
Non-banking finance, that which is not regulated, has become the true heart of the financial system. Today it weighs half of the global financial market, as much or more than the banks. Its players have enormous vulnerability: they have gone into extreme debt, taking advantage of ten years of zero interest rates. If they collapse, they will cause a domino effect that no amount of capital can cover. Bringing in their wake the banking sector and the real economy.
These big speculators, or “Big Spec,” as they are called on Wall Street, borrow to speculate. They don’t invest their own money, they do everything on credit (at zero interest). We generally admire the hedge funds for their highly risky and sophisticated strategies. They invest with a large leverage effect, take dizzying bearish bets, without always holding the securities concerned, use and abuse derivative contracts, virtual and unfunded, lend funds that they themselves have borrowed, or rely on algorithms that all do the same thing. In short, this is what is commonly called the stock market casino.
And the casino is much less regulated than the banks! These players and their strategies are not subject to the same supervision or the same capital requirements, on the pretext that they have no depositors. A bit like lifting the speed limits for sports cars on the highway, on the grounds that they carry fewer passengers. By forgetting that they endanger all the others.
When the casino breaks the bank
Thus, non-banking finance, which is also called shadow banking system, has been deliberately kept out of the regulatory field since 2008, in order to preserve the attractiveness of the American market and its “Wolf of Wall Street” side, which has contributed so much to the myth. But today, these actors have the power to infect banks in various ways, through the exposure of the latter to their strategies.
Credit Suisse has been knocked down by rampant speculation in its own credit derivatives (the securities that indicate its likelihood of bankruptcy). A bank can lend money to a venture capital fund (this was the case with Silicon Valley Bank). A bank can co-invest with a hedge fund (this was the case of Credit Suisse with Archegos). It can be a consideration for highly speculative products used by some of these players. The banks’ exposure to non-banking speculation has almost doubled in ten years.
Therefore, the freezing of confidence that can target a large bank signals a reality: its exposure to this speculative finance is high, and this annihilates the supposedly reassuring effect of its high capital ratio. Because the main thing does not happen on its balance sheet, but off its balance sheet.
A wooden check of 1.5 times the world GDP
Who favored this speculation on credit by non-bank players? Central banks. By keeping its rates at zero for almost the entire period between 2009 and 2021, the Fed has fed a veritable Everest of risks. The mass of speculative credit from non-banking finance has increased from 67,000 billion in 2011, which was already enormous, to 152,000 billion in 2021, according to the latest G20 report. Half of this amount represents direct systemic risk. On this graph, we can see how this mass of speculative credit has exploded over the past ten years:
This is a phenomenal amount, for largely unfunded speculative loans. A bad check, in short, of one and a half times the world’s GDP.
Problem: When inflation hit two years ago, it forced central banks to raise interest rates like they had never done in 15 years, ending the intoxicating easy money the steps. In 2016, in a book that I co-wrote on the shadow banking, we made a radical observation: that American interest rates could never rise again because of this mass of non-banking speculative credit. I compared it to an overinflated balloon, which the rate needle could only burst. The observation, then vertiginous, is in the process of being verified.
A pinned grenade
This April 4, 2023, an IMF report confirms this prediction. He notes that the mountain of risks in the non-banking sector, closely connected to banks, has become enormous. And that the rise in interest rates therefore poses a problem for global financial stability. The easy option, that of lowering interest rates again to 0%, no longer exists: inflation is far too high and that would increase it tenfold.
Only one solution: the regulators must force the actors of non-banking speculation to cover their risks and acquire sufficient capital. And above all, to get out of debt. What’s worse is that China has been doing it since 2017, campaigning for actors in the shadow banking get out of debt, while the United States let slip the debt of these actors. Making them accountable will ultimately protect the employees of the real economy, who will not accept indefinitely that these growing and uncontrolled drifts are mopped up.
Myret Zaki, holder of an MBA from the Business School Lausanne, has been a financial journalist for 23 years. His specialties relate to the economic and banking world, stock markets and investment, national statistics, but also institutional disinformation and information warfare.
After nine years at Tempsshe was editor-in-chief of With from 2014 and 2019. She writes today for Blick, With et TheMarket (NZZ). Author of five books on finance, she won the 2008 Schweizer Journalist Prize for UBS, the underside of a scandal (2008, ed. Favre). In 2022, she published Economic misinformation (ed. Favre).