Shadow banking steps out of the shadows

In a recent article I mentioned that former Federal Reserve Chairman Ben Bernanke initially had difficulty refinancing his mortgage. When I decided to downsize from my house to a condo, I opted to have a modest mortgage for tax planning purposes.

But after seeing the never-ending list of documentation that the bank required, I decided to forgo the tax benefits provided by a mortgage.

Since the meltdown of 2008, the banking industry lending standards have been significantly tightened. And there’s a long laundry list of new regulations including those in the Dodd-Frank bill.

You would think with interest rates at record low levels that businesses and households would be flooding the banks with loan applications. But, many have scars from the financial meltdown in the form of less than a stellar credit rating. Or perhaps they depleted their savings account in order to survive the downturn.

Because of such previous setbacks and the need for loans, a low credit rating is forcing many to seek alternatives to traditional banking for business and personal loans.

These banking alternatives are commonly referred to as shadow banking, which is becoming a booming enterprise and emerging from the shadows as real competition for traditional banks.

Many used to think of shadow banking as pawnshop loans and establishments that offered cash advances on paychecks. But today it’s much more.

It’s estimated that the non-traditional banking environment in this country has grown to more than $3 trillion. Small wonder. Because unlike the traditional banking system which is regulated and monitored by a plethora of regulators, the shadow banking industry is under the radar of watchdogs.

Some would argue that lack of regulation is a godsend. But others might fear that it could be the next big problem because nobody is paying attention.

I tend to be more of a traditionalist and favor traditional regulated banking. But I can certainly sympathize and understand those that turn to the shadow banks for help.

Shadow banking is serving a segment of the population that needs capital but doesn’t meet the strict guidelines that the banking industry follows.

Shadow banks can have significant differences and are all over the board. A typical transaction for a $1,000 loan, for example, might have a loan processing fee and an interest rate at around 6 percent.

Yes, their rates and fees are likely to be higher than a traditional bank, but if you had some financial problems in your recent past, this just might be the only way you can obtain a loan.

Recently, the well-known PayPal announced it would be entering this shadow banking space. The non-banking industry is not only looking for borrowers, they’re also seeking investors that have the money that is needed to make these loans.

I would be very careful from this end as well. I see a definite potential for investors to take it on the chin. Again, it’s the lack of regulation that concerns me.

As shadow banking moves from the shadows and closer to Main Street, I suspect we’ll hear from legislators after problems arise. Don’t get me wrong; traditional banks don’t serve the needs of everyone. But when you step into a game that lacks rules, don’t be surprised when you encounter a lot of problems.