The purpose of this paper is to review the continued development of the “shadow banking” market in the USA, namely, lending to the private middle market, defined as financings of $5-100m to non-public, unrated operating entities or pools of assets with not more than $50m in earnings before interest, taxes, depreciation and amortization.
The analysis includes a continued review of an innovative segment of the financial markets and primary evidence from direct participation in four actual cases of private, non-bank lending between 2013 and 2015 and theoretical observations around that data.
Although there have been considerable challenges, historically, in providing credit for small and mid-sized businesses in the USA, the authors show further evidence that private middle market capital is growing (post credit crisis) at a dramatic pace, in part because of excessive constraints placed on the regulated depositary institutions. The authors also explain the nature of the shadow banking innovation and how it is intrinsically linked to “arbitraging” often excessively restrictive banking regulation. The growing US shadow banking market, while providing an important service to middle market companies, may pose a new systemic risk post 2007-2008 credit crisis in the USA.
Any generalization is limited because of the difficulty in extrapolating from a small number of specific case studies and the absence of adequate survey data for the US capital markets and the limited examples examined.
This research calls for additional case studies, including participant observation research that offers a unique close-up view of financial behavior that is often beyond the view of regulators and the public. Data obtained may be useful in providing a deeper, more timely understanding of credit market behavior and contribute to efforts at formal financial modeling as well as the development of practical regulatory regimes.
The shadow credit market is a key source of funding for the global financial system, thus contributing to job creation and economic growth. The authors demonstrate the value of financial innovations and show that shadow credit fills a void left by depository financial institutions, shifting much of the risk from the public to investors. This research increases transparency in the operation of this market, which is extremely important for the industry, the government and the public. The authors offer a modest attempt at understanding credit behavior to avoid a repeat of the 2007/2008 financial crisis.
Direct participation is unique to the firms studied. Value is in developing a general framework to analyze an emerging credit market in advanced economies.
The authors want to thank Gerald L. Brodsky for his critical review and insightful comments at various stages of this research, and Richard J. Kelly for his excellent research assistance. Mr Kelly passed away due to amyotrophic lateral sclerosis in August 2017. Finally, they thank the anonymous reviewers for their suggestions and criticisms that improved this paper immeasurably. Co-author Jeremy Josse passed away unexpectedly on June 12, 2018; Dr Zabala wishes to note that Mr Josse’s contributions to this research paper were innumerable.
Zabala, C. and Josse, J. (2018), "Shadow credit in the middle market: the decade after the financial collapse", Journal of Risk Finance, Vol. 19 No. 5, pp. 414-436. https://doi.org/10.1108/JRF-02-2017-0033Download as .RIS
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