Increase in “shadow credit” as consumers turn to risky loans

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Banking bosses in the UK have warned that increasing numbers of consumers are relying on “shadow credit” during the cost-of-living crisis, taking out risky loans from the darkest corners of the financial system.

“I think there is a concern out there that people are moving more and more towards unregulated credit,” Natwest retail bank chief executive David Lindberg told the Financial Times.

“What you would find is if you look 15 or 20 years ago, credit stress is housed in the banking system. Today it is found in ‘buy now, pay later’ bills and collections from government agencies and in many cases from less regulated and 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 on their loan books. “Arrears — or overdue payments — at the big banks are still historically low,” said Gary Greenwood, an analyst at Shore Capital.

But even as analysts hail the resilient balance sheets of big banks, some bankers have warned that the unregulated shadow lending industry could 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 that are about to become more stringent for banks, this situation will only get worse”.

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

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

Research by the Center for Social Justice, a UK think tank, estimated that more than 1 million people borrowed from illegal moneylenders in 2022, up from 310,000 in 2010.

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

Gerard Lyons, chief economic strategist at investment manager Netwealth, said people should generally be “wary” of finance in the shadows. “We have to distinguish between the areas of the shadow banking system 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 the shadow banking system, conducting a “system-wide stress exercise” of non-bank and traditional lenders “to help us map risks.”

Andrew Bailey, governor of the BoE, said the “problems” related to shadow banking “bear a striking resemblance to the secular challenges of finance, such as leverage and interconnectedness with other parts of the financial system, creating the possibility fallout and systemic consequences”.

Buy now, pay later – a popular form of short-term credit which has faced criticism over the affordability of its loans – is expected to be regulated by the Financial Conduct Authority. Under government plans unveiled in February, the watchdog would gain powers, including banning companies from making loans if they don’t complete proper credit checks.

Additional reporting by Chris Giles