The City is quietly panicking over the fact that AI losses might already be muting in the shadowy world of shadow banking. As The Telegraph reports this morning:
The $2tn (£1.5tn) private credit industry is being quizzed by the City watchdog over fears its unrecognised losses could fuel a financial system meltdown, The Telegraph can reveal.
Officials from the Financial Conduct Authority have in recent weeks been piling pressure on so-called shadow banks – an increasingly critical source of funding for the speculative AI boom – to more rigorously mark down the value of loans that are at risk of not being repaid in full.
The FCA's confidential discussions were revealed by City sources amid growing concern about the rapid rise of private credit funds, which compete with traditional banks to make loans to companies. Private credit assets will be worth almost $4tn by 2030, according to a recent report by Moody's.
Three things are worth noting.
First, shadow banking is popular. The scale of its investments is forecast to double between now and 2030. Reduced accountability coupled with lower regulation appeals in the murky world of finance.
Second, supposedly, the same accounting rules apply to loan recognition in regulated banks and shadow banking. The clear implication of the report is that no one thinks they are being treated in the same way, across the board. That requires auditor cooperation, then: shadow banking is still subject to the full audit regime. Who would have thought the audit profession might be involved in another scandal in the making?
Third, without data, the risk of a crash cannot be managed. We might be flying blind already.
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Are these private credit providers or shadow banks allowed to make loans that ‘create money’ ?
Or will they be losing actual rich people’s money when the stocks crash? Are pension funds involved here as well or are their investments more transparent and better regulated?
I ask because I am trying to work out if we are allowing large loans to be made for speculation that will not be repaid and that will therefore leave ‘extra’ money in the money supply…. Causing more inflation and effectively wiping out any wage increases and benefit increases?
Shadow banking raises its funds from the same underlying sources as the formal banking system, but it does so without taking insured retail deposits and without access to central-bank backstops. Its funding is therefore more market-based, wholesale, and inherently fragile. Pension funds, money market funds and hedge funds are all major providers.
When you say ‘raises funds’ do you mean the shadow banks just ensure liquidity by taking in funding in one way or another; or do they make loans out of those deposits?
In other words, are they intermediating funds; or are they making loans (with or without collateral) based purely on the credit worthiness of the borrower and the lender’s expectations of repayment: creating new money ‘ex nihilo’ in the manner of BoE Quarterly 2014:1 (or whenever exactly) “banks create money when they make koans”?
If the latter, are they licenced to do that in a similar way to regular banks, or completely outside those controls (hence, ‘shadow’)?
Take funds mean they borrow, and then lend. These are shadow banks: they do not creat funds by lending. They are outside many banking controls.
Where is the money invested in private credit coming from?
Pension funds, I suspect.
Thank you, Richard.
Aka the dumb money.
From 2012 – 4, I worked at the buy side trade body. I remember a call from the Universities Superannuation Scheme, panicking about an EU crackdown on alternative investment funds. The person, much to my amusement and disgust, was worried about hedge and private equity funds.
I could not understand why the USS subcontracted to these sharks.
With regard to regulation, let’s not forget that Carney, at the Bank of England, fought against the regulation of shadow banking. I have often wondered how long this missed opportunity would take to come and bite.
USS has a history of stupid investment decisions, as I know.
Thames Water, anyone? USS said, yes please.
Thanks for a profoundly disturbing article.
Do the Prudential Regulation Authority and the Financial Conduct Authority haveany influence/control over “Shadow Banks”?
Does any governmental body?
By definition they don’t.
But they do through the credit advanced to them by regulated banks.
Hence the questioning supposedly happening now.
Thank you, both.
The authorities could have done so, given themselves the tools, but chose not to.
One person who resisted, not a surprise given who he has worked for and where his money is, is flavour of month after speech at Davos.
🙂
It ought to be the case that the rise of Private Credit reduces systemic risk… indeed, it might be. But, as you point out, we just don’t know.
On the positive side, credit risk is transferred away from the banking system….. but the problem is that the banks just load up with more risk. This leaves the whole system with more debt.
Now, if PC funds were unleveraged this would not be an issue. If we had a credit crash their investors would lose their shirts but move quietly on with no systemic impact. (Indeed, this is largely what happened in 2008 with Hedge Funds – large losses but no systemic issues).
However, they are leveraged….. and a lot of that leverage comes from banks which are systemically important. One could consider Private Credit as economically equivalent to a CDO (Collateralised debt obligation)… and we know how that ended. I have no problem with the concept of securitisation of assets into CDOs in principle but in practice, these vehicles get stuffed with poor quality assets and this eventually ends in tears.
So, what to do? First, limit the credit provided to PC by the banking system – if PC goes belly up it must not infect the banking system. Second, recognise that non-banks need more supervision as well – mainly with regards to leverage limits.
The risk to banks is in the paper PCs issue – and there is a lot of it.
And who appraises it? Don’t ask..
Much to agree with in your post
Thank you, both.
My former employer, Dutch, and a leading UK high street bank, not one usually associated with such risks, have increased such exposure in the past year or so.
In the latter, British case, a new CEO from a more international British rival has prioritised investment banking, the US, EU and far east.
As the ring fencing and senior manager accountability rules are watered down, on the grounds of competitiveness, risk taking with retail deposits will rocket.
Thank you and well said.
The relevant rules, AIFMD, were watered down. This is one reason why such funds / investment firms backed Brexit.
I happen to think that Dr. Tim Morgan is likely very much on the right track, Richard – see what you think.
https://surplusenergyeconomics.wordpress.com/2026/01/30/318-the-surplus-energy-economy-part-one/
I am going to have to disagree, Mark.
This is an interesting piece, but I think it goes wrong in two fundamental ways that matter a great deal.
First, this is not MMT, despite occasional overlaps in language. MMT does not deny material constraints, energy limits, environmental degradation or the distinction between the real and the financial economy. On the contrary, those constraints are central. Where MMT parts company is in rejecting the idea that money must be forced into line with the “real economy” through some supposed restoring equilibrium mechanism. Economies are not systems that naturally return to balance. They are dynamic, path-dependent, institutionally shaped processes. We are never in equilibrium, and pretending that we are—or must be—leads directly to false conclusions.
Second, the claim that “excess claims must be eliminated” because the monetary economy has outgrown the material one is precisely where the argument becomes dangerous. That framing treats crashes, defaults and asset destruction as quasi-natural, even necessary events. MMT rejects this outright. There is nothing automatic or inevitable about “eliminating claims”. Inflation, asset price collapses and debt crises are policy outcomes, not thermodynamic necessities. They happen because governments choose not to regulate credit, asset markets, energy transitions and distribution properly.
The analysis also collapses into a familiar error: assuming that monetary expansion necessarily reflects hubris rather than political choice. The problem of recent decades is not that governments spent too much to sustain material wellbeing. It is that they allowed private credit creation to explode while public investment in energy transition, care, housing and resilience was systematically suppressed.
Finally, the equilibrium framing misses the most important issue of all: distribution. Resource limits do not require mass immiseration or financial collapse. They require deliberate allocation decisions about who consumes what, who owns what, and who bears adjustment costs. Treating collapse as unavoidable conveniently absolves power.
In short, this is not an accurate monetary theory. And its reliance on equilibrium thinking leads it to mistake political failure for physical inevitability. I am not convinced as a result.
Thank you, Richard. It’s the idea of ECoE that if find most interesting. We have a client who works as an oil rig engineer for BP. Not so long ago she mentioned that the ‘low hanging fruit’ in most places has been long picked. Setting aside the oil/climate change situation for a moment, I was struck when she said that oil needs to be $250 a barrel to make hard to get at reservoirs slightly worthwhile. There is a lot more plastic around now as this is made, so I understand, from ‘light’ oil whereas diesel which moves everything around needs ‘heavy’ oil which, I’m told comes from Canada, Russia & Venezuela, but I’m no expert.
I think your information sounds accurate.
In 1971 the Conservative ‘Competition and credit control Act’ allowed ‘secondary banking’ which, is, I think, the same as shadow banking. It didn’t seem to invest much in newer products but mainly in property. In 1970 , after much scrutiny, I was able to buy a house for £4,950. In 1973 I moved and sold it for £10,800 yet my salary had only increased by a few hundred. The Act was repealed in 1973 and the bank of England offered a ‘lifeboat’ to a number of financial institutions.
For several reasons the 70s were a time of inflation, blamed by the press on trade unions ( I recall Enoch Powell ! saying it wasn’t their fault ) I now know there was a banking act a few years later.
We then in the 1980s had another Conservative bright idea -monetarism -which was abandoned a few years and few million unemployed, later.
In the 1990s we had the ERM crisis. In the early 2000s along with Labour ‘light touch regulation of the City’ was bringing in the bucks as someone described it.
After both of these setbacks we had austerity and then Brexit.
To a simple soul like me, my conclusion is bankers , politicians and newspapers who support them , don’t really understand economics and need regulation. They have not invested in the right things in the right way and they have cost us proles a lot of money.
Richard and his commentators do a great job in exposing their shortcomings and offering solutions.
“To a simple soul like me, my conclusion is bankers , politicians and newspapers who support them , don’t really understand economics and need regulation. ”
Correct
When you talk about shadow banks Diss this include private banksike Wetherby Bank that serves the wealthy and super wealthy?
How many of these private banks exist, whatcarectgeurvhokldings, what do they do withe money they holds and what is their role/significance in the economy?
To the first question, that sounds like a regulated bank. Shadow banks do not take deposits.
Second, shadow banks essentially borrow funds in bulk and lend it at greater risk, hoping to make a margin from their expertise.
I wonder if the sudden sharp falls on Friday in the prices of gold, silver, platinum, palladium, etc might pressage the start of a correction. This sort of volatility rarely ends well – for example, if some people have been borrowing large sums to invest in the expectation of prices continuing to rise.
https://www.ft.com/content/d3260ce9-94b5-4200-80a2-3d90e9031d98
I decided to wait another day or two
Monday may be interesting
Might the attached articles from today’s CHINADAILY be of interest as possible contrasts to shadow banking?
https://www.chinadailyasia.com/hk/article/628127
https://www.chinadailyhk.com/hk/article/617107
Thanks! (The second article is from last July, btw )
Discussion on this thread has been about lack of regulation of over-liberalised markets. China by contrast is very much state (directed) capitalism, with ‘strong guidance’ of both industrial policy and investment, purchasing decisions of state enterprises, and direction of finance.
Despite that, the financial sector has problems with non-performing loans (eg for property construction); so ‘direction’ can make serious errors and also allow inappropriate developments. But the state will quietly arrange bail outs; and it’s spokespersons on China Daily will report successes or practical problems being solved: ‘move along, nothing to see here…’
So, humans make mistakes? What’s the surprise?
That city watchdog fretting about the financial system meltdown…. In the best of worlds they would have a room full of screens connected to computers that run models of the system. They feed various scenarios, parameter changes and see the dangers ahead.
In my worst imagination reality is different. No computers, no whiteboards with equations, no paper at all. A room full of people talking with the end product being paragraphs of text.
Is it not so that there is no system model that holds, no one idea of a system, no modeling? Just ideas held in minds of people?
As the meme says: change my mind.
Have successive U. K. governments facilitated/connived at the growth of shadow banking?
If so, what might be the reasons/purposes?
They have not regulated the sector. That has promoted its growth.