Photographer: John Taggart/Bloomberg

Shadow Banks Make Diciest Loans While Wall Street Retains Risk

Wall Street has cut its lending to the riskiest companies, shifting its financing to nonbanks that make the loans instead, according to a team of analysts at the Federal Reserve Bank of New York.

“Since those policies reach beyond individual banks and target risk in the entire banking system, they are more likely to trigger significant responses that may have unintended consequences,” said the report by Sooji Kim, Matthew Plosser and João Santos.

Nonbanks, part of what’s called the shadow banking system, are financial institutions that don’t take deposits and fall outside the purview of banking regulators. They’ve increased their borrowing from banks, possibly to finance their growing leveraged-lending activity, the study found. That means regulated banks may still be vulnerable to the stability of institutions that took their place in lending to companies that heap debt on their balance sheets.

Curb Risks

The Federal Reserve, the U.S. Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. have been waging a three-year effort to curb excessive risk-taking by the banks they oversee.

The volume of syndicated term loans originated by banks peaked around the first quarter of 2013 and has declined since, according to the New York Fed report. Banks that may pose elevated risks to U.S. financial stability reduced their leveraged lending most aggressively in response to the guidance.

“This reduction in lending, however, did not necessarily result in an equivalent risk reduction because nonbanks increased their borrowing from banks,” the analysts wrote.

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