UBS raises alarm over ‘shadow banks’ as lending clamps tighten on big four

A tightening of credit standards at the major banks has led to a worrying surge in ‘shadow bank’ lending, says UBS.

Piggy banks with the logos of the big four banks. Picture: The Deal

The regulatory crackdown on lending standards has been heavily skewed toward the major banks, resulting in a “concerning” trend that has pushed credit down into the ‘shadows’ of the smaller banks and the non-banks, UBS has warned.

Unless all lenders receive similar scrutiny this regulatory mismatch may lead to “sub-optimal economic outcomes”, UBS banking analyst Jonathan Mott said in a research note.

Housing credit for the big banks over the three months to May grew at the lowest relative rate since the financial crisis, UBS said. While the majors’ growth slowed to 3.7 per cent annualised in the quarter, shadow banks took advantage of the shackles imposed on the big lenders and swelled their books by 12 per cent.

“This would suggest that much of the credit tightening by the major banks year to date has been offset by the smaller banks and nonbanks, a situation we believe is concerning,” Mr Mott cautioned.

“We believe that many of these players do not receive the same level of regulatory oversight as the majors and may not have the sophisticated systems required to meet the stricter hurdles of responsible lending which are expected to be reinforced by the royal commission, “ he said.

Mr Mott estimates that that mortgage funding by the major banks will fall by around 20 per cent in the next year, equivalent to a $56bn drop in new lending. To pick up the slack, the smaller banks and non-banks would have to lift their originations by more than 50 per cent.

“We do not believe the smaller banks and non-banks have the operational or funding capacity to absorb such a large increase in flow — this would be unprecedented,” he said.

Higher funding costs, lack of scale and the prospect of tighter regulation would hamper shadow bank efforts to keep filling the growing lending hole left by the majors.

Rising funding costs have already forced some of the smaller players, including BoQ, AMP and IMB Bank, to lift their standard variable mortgage rates. Others will likely to need to follow their lead or face a material hit to profitability, UBS said.

“As a result, we believe higher funding costs may lead some of the smaller banks to reduce their application volumes and slow balance sheet growth,” the note said.

Mr Mott believes it’s only a matter of time before regulators turn their attention to shadow bank lending and that the royal commission will result all lenders having to a adopt a stricter interpretation of responsible lending.

“While the major banks will be able to absorb these costs, such technological investments may be prohibitive for many of the smaller players. Therefore, we believe that any potential regulatory mismatch benefiting the smaller banks and non-banks is unlikely to be sustainable,” he said.

UBS remains very cautious on the outlook for the banks and says risks are skewed to the downside. Following the bounce the banks are not cheap on a forward PE ratio of 13.1x and a price-to-book ratio of 1.6x.