By Tomek Jankowski
In the 1993 Steven Spielberg film Jurassic Park, the protagonists discovered at one point (to their horror) that the island's dinosaurs, which had all been created the same gender, had somehow managed to reproduce. "Life always finds a way," muttered Sam Neill's character Dr. Alan Grant as he stared at recently-hatched dinosaur eggs.
As the smoke began to clear from the 2009 global economic crisis, the world's financial institutions did kind of look like someone had let loose a bunch of particularly irate Tyrannosaurus Rex. Many analysts and economists, surveying the financial wreckage, pointed a finger at a diverse group of financial players known collectively as the shadow banking system (SBS). Hedge funds, money market funds, retirement funds, life insurers, consumer finance companies, any non-bank financial services entity that could lend money had all become part of an institutional shadow lending network.
Even banks got in on the act through the repo market, and special SBS units known as "Structured Investment Vehicles" (SIVs) were created by investment banks in the 2000s to keep their bond portfolios in play via lending. By 2008 the SBS market amounted to roughly $50 trillion, but it all collapsed in the economic crisis. SBS lending seized up as the mortgage-backed security (MBS) market went belly-up in 2009, causing the global credit crunch. SBS went down, quickly becoming as extinct as T. Rex.
Except that the G-20's Financial Stability Board just issued a report in late 2012 that clocked apparently resurrected SBS lending at about $67 trillion, or about half the world's (formal) banking assets. How can this be? SBS is the financial world's L'enfant terrible, in part because much of the lending happens in ways that keep it from the prying eyes of government regulators… and shareholders.
But shadow banking survives because it makes cash and credit-starved markets more liquid, while providing a further profit outlet for otherwise stagnant or "tied up" assets. And SBS encourages both pricing and product innovation by connecting "savers with borrowers in ways that conventional banks can't," to quote Bloomberg economics editor Peter Coy.
The market always finds a way.
So what is a consultant to do? SBS seems like a direct competitor to traditional banks who comprise a large part of consulting firms' clientele in financial services. Is SBS is a threat to consultants' bread and butter? Well, SBS is an organic outgrowth of a need for creative forms of finance able to tread in places where banks dare not—or, due to regulatory constraints, cannot—go.
To be sure, there are risks; as the 2009 crisis illustrated, SBS financiers are as vulnerable to bank runs as the traditional banks, and the Financial Stability Board's report likely foreshadows new regulations targeting SBS lending.
However, adversity means opportunity to consultants, who can help SBS players formalize their lending processes, develop (internal and external) reporting standards (to help stave off some regulations), devise capital requirements in anticipation of probable regulations like banking counterparts, and most importantly, help lenders, borrowers and regulators develop clear risk assessments and profiles that will help bring some cogency and transparency to this burgeoning market.
And even if SBS is now a competitor to banks, it's still easier to find a way to sell consulting to SBS providers than it is to their alternative: the mafia. Whether the world likes it or not, this baby has been born. Consultants now have the opportunity to help it mature and reach its productive potential.
Tomek Jankowski is Senior Analyst and Lead, Financial Services Consulting for Kennedy Consulting Research & Advisory. He can be reached at customercare@alm.com.
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