The Rise of Shadow Banking

LOS ANGELES—Shadow banking has come under public scrutiny because the sector isn’t held to the same regulatory standards as mainstream banking, and many believe that makes the sector riskier. However, Harlan Peltz, the co-executive chairman of iBorrow, says that the criticism is often unwarranted because the so-called shadow banking sector is a benefit to the lending community. To find out more about shadow banking, why a borrower would turn this market and where it is headed, we sat down with Peltz for an exclusive interview. What exactly is shadow banking, and why has it emerged?

Harlan Peltz: I think of shadow banking as the collection of financing transactions that occur away from the traditional sources of finance, whose activities are generally not subject to direct regulatory oversight What types of borrowers turn to shadow banking, and why?

Peltz: There are many reasons borrowers or deals are handled through the shadow banking system.  In the context of the loans we originate, the borrowers we serve generally fall into one of two categories: first, they need loans quickly, quicker than traditional banks’ typical underwriting process, or second, their credit is substandard based on the criteria of traditional lenders, which base lending decisions mostly on a borrower’s credit score. Since we are basing our lending decisions primarily on the value of a borrower’s collateral, we can evaluate loans to borrowers with low credit scores. Shadow banking has been stigmatized. Why, and is that fair?

Peltz: I don’t think shadow banking has been stigmatized as much as it’s been politicized.  In the context of the 2008 financial crisis, when lots of blame could be fairly meted out, “Wall Street” became (and remains) an easy scapegoat and the activities of shadow banking became an easy lightning rod for criticisms.  I think some of the criticism is fair, but I think the majority of those who criticize do not understand, because shadow banking does fill in critical gaps within the financial ecosystem—to provide necessary liquidity and enable risks to be managed.  Without shadow banking, the financial system would be a far scarier and uncertain place. Because shadow banks are not held to the same regulatory standards as banks, should there be regulations put in place to oversee and monitor these entities?

Peltz: I think the cost of regulation needs to be weighed against its benefit.  The first task is to define the problem and the activity – once we have answers to these questions, I think we would have a better perspective on whether and to what extent regulations should be imposed.  I’d also add that regulations cannot eliminate bad or illegal behavior – we have Courts for that.  I think regulations can have chilling effects on markets and many times politicians believe they can impose a “fix” through regulations, which is not always true. Shadow banking has grown in popularity over the past few years. Do you expect that to continue in 2016 and beyond? What is your forecast?

Peltz: I do expect the trend to continue.  Post 2008, a lot changed due to regulations and corporate decisions within the traditional banking system.  These changes have created enormous new opportunities for non-traditional finance.  Our business is an example of this and our growth and trajectory reflect incredible demand that is not being served by traditional providers.

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