Rise of ‘shadow credit’ as consumers turn to risky loans

Bank bosses in the UK have warned that growing numbers of consumers are relying on “shadow credit” during the cost of living crisis by taking out risky loans from the murkier corners of the financial system.

“I do think there’s a worry out there that people are moving more and more into unregulated credit,” David Lindberg, chief executive of Natwest’s retail bank, told the Financial Times.

“What you’d find is if you look 15 to 20 years ago, credit-related stress is housed in the banking system. Today it sits in ‘buy now, pay later’, in utility bills and collections from government agencies and in many cases from less regulated, high interest rate credit providers or ‘friends’,” he added.

Despite rising interest rates and double-digit inflation, high street banks such as HSBC, Lloyds, NatWest and Barclays have shown little sign of stress in their loan books. “Arrears — or overdue payments — at the big banks are still low historically,” said Gary Greenwood, analyst at Shore Capital.

But even as analysts cheer the resilience of big banks’ balance sheets, some bankers have warned that the unregulated shadow lending sector might mean the financial system is less stable than it appears.

Nigel Terrington, chief executive of Paragon Bank, said: “Shadow banks tend to play on the risky edge of credit markets as they exploit regulatory differences. With [regulatory] requirements about to get tougher on banks, this situation will only get worse.”

Greenwood added: “Banks have been de-risked since the financial crisis and that risk has been pushed into shadow banking. It’s where all the bodies are buried.”

Riskier types of credit are becoming prevalent as the cost of living crisis pushes people into more expensive forms of short-term debt.

Research from the Centre for Social Justice, a UK think-tank, has estimated that more than 1mn people borrowed from illegal money lenders in 2022, compared with 310,000 in 2010.

Non-bank finance amounted to $239tn globally in 2021, according to the Financial Stability Board, an international body of major economies. Shadow banking now represents nearly half of the world’s total assets. The FSB said in the UK, based on a narrower measure of non-bank finance, shadow banking had reached $1.7tn, up from $900bn in 2008.

Gerard Lyons, chief economic strategist at investment manager Netwealth, said people should generally be “wary” of finance in the shadows. “We need to differentiate between areas of shadow banking that cause financial instability and those that provide funding to parts of the market that need it, where banks are not filling the space,” he added.

The Bank of England said last month that it was monitoring shadow banking, conducting a “system-wide stress exercise” of non-banks as well as traditional lenders “to help us to map out the risks”.

Andrew Bailey, governor of the BoE, said “issues” around shadow banking “bear a striking resemblance to ages-old challenges in finance, such as leverage, and interconnectivity with other parts of the financial system, creating the scope for spillovers and systemic consequences”.

Buy now, pay later — a popular form of short-term credit that has faced criticism over the affordability of its loans — is due to be regulated by the Financial Conduct Authority. Under government plans unveiled in February, the watchdog would gain powers including banning companies from lending if they fail to complete adequate credit checks.

Additional reporting by Chris Giles