A growing body of academic literature has found extensive links between non-bank financial institutions (NBFIs) — a category that includes hedge funds and private equity, as well as private credit — and the traditional banking sector.
“Through these linkages, shocks can propagate rapidly across entities, sectors, or jurisdictions, especially when multiple institutions respond simultaneously to market stress,” said the authors of a paper at this year’s ECB research conference in Sintra, Portugal. They wrote that nearly one tenth of banks’ assets in the European Union were claims on NBFIs, and that 10-15 percent of banks’ deposits also came from non-banks.
Loriana Pelizzon, deputy scientific director at the Leibniz Institute for Financial Research and one of the authors of the paper, said she wasn’t overly concerned about the two bankruptcies, given the relatively small size of the auto financing market. However, she said that interlinkages between European NBFIs and the U.S. financial system needed to be monitored, given the scale of the investments.
“There’s a significant amount — trillions and trillions invested — in the U.S.,” she said, noting that investment chains are often long and complex, and that regulators lack insight into them.
“The question is whether this is just a couple of rotten apples,” said Davide Oneglia, director at economic consultancy TS Lombard. He said that the risk in the private credit segment will grow further if U.S. interest rates don’t fall as quickly as expected, for example, due to high inflation. That would put a further squeeze on private credit providers.
In plain sight
But it’s not just private credit that has policymakers on tenterhooks. The benchmark U.S. stock index S&P 500 is now trading at nearly 30 times the expected earnings of its components, far above its long-run average, and closer to the freak levels seen during the Dotcom boom and the pandemic.