Explainer: Five Megatrends Shaping the Rise of Nonbank Finance

The global financial crisis of 2008 froze the financial system. Banks pulled back credit, families tightened their belts and companies laid off workers. It was a frightening time for everyone, and an extremely difficult moment for the financial services industry.

Today, the landscape of finance is quite different. Different types of investors and firms are providing businesses, consumers and governments with credit and liquidity. More than a billion more people have access to credit thanks largely to newer tech-based lenders. Families also have more options to finance purchases and to diversify retirement portfolios. Equity, fixed income, and derivatives markets have all seen strong growth.

But these developments have not been driven by banks. Instead, it is "nonbank" financial institutions that have stepped up, increasing their share of global credit and finance from 43 percent during the 2008 crisis to nearly 50 percent by 2023, our most recent data show.

This is a watershed moment: half of all financial services worldwide are now offered by companies that are not classified and regulated as banks.

Nonbank financial institutions encompass very different kinds of enterprises, and exact definitions vary. Broadly, the sector includes financial companies that provide credit, trading and investment services but don't take deposits from the public or have accounts with the central bank. That means they aren't covered by safety nets like deposit insurance and liquidity assistance, which banks have access to in exchange for comprehensive prudential regulations.

The megatrends

Given nonbanks' size and importance, it's worth looking into the megatrends driving their growth.

• Governments have new lenders, enhancing liquidity and holding down rates: New nonbank buyers for bonds such as US Treasuries provide additional liquidity. This helps markets operate efficiently, which can help hold down the interest on national debt that taxpayers ultimately pay. In the United States, principal trading firms such as Citadel Securities and Jane Street Capital have developed business models around technology-driven high-frequency and algorithmic trading that have fueled this trend.
• Mid-sized businesses have gained more access to funding, supporting economic activity, employment, and financial resilience: Private credit funds can provide funding for businesses that may be too large or risky for banks to lend to, but too small to issue their own bonds. Many such funds are managed by private equity firms, which in turn get financing from banks and other nonbanks. These nonbanks-typically insurers, pension funds, sovereign wealth funds, and endowments-that provide funding to private credit funds tend to have lower leverage and funding that is more stable over longer terms compared to banks. So, they don't have to pull funds back as quickly during times of stress, increasing the financial system's resilience.
• More borrowing options for consumers and small businesses: Credit is available in a wider variety of amounts and durations, from longer-term auto loans, to "buy now, pay later" loans, and small mobile money loans in countries like Kenya. Fintech lenders have driven this trend by pioneering new sources of data for underwriting and making servicing cheaper through automation, enabling firms to make smaller loans to more people. In emerging and developing economies, they have made mobile payments available to more people, and with a broader set of financial services following behind.
• Investors of all sizes have more ways to diversify portfolios. Investment funds, and particularly passive investment vehicles, have expanded access to capital markets for individual investors. As returns on the safest assets dwindled, index funds rapidly increased their share of assets under management-from 19 percent in 2010 in the United States to 48 percent by 2023. And nonbanks made new asset classes, including commercial real estate and precious metals, available to more investors. More diverse assets can help all investors manage risk, although speculative assets have risks of their own.
• Beyond diversification benefits, another feature of passive investing merits mention: certain types of funds can provide a new stabilizing force for markets. One feature of these funds is that, to maintain the balance of stocks they promise to end-investors, they regularly and predictably buy more of the shares that get cheaper and sell more as their value rises. For example, when individual stocks rise enough to be added to a benchmark equity index, or are removed from it if their value falls. As they've attained great size, this dependable effect has helped to stabilize markets.

These trends show the benefits of nonbank innovation. But their growth also brings risks.

What could go wrong

The classic "run on a (non)bank" scenario: Like banks, open-ended and money market funds make long-term investments but promise customers the ability to withdraw at any time. So, during the early-COVID "dash for cash" in 2020, some were running out of cash (a liquidity crisis) and needed help from central banks, including the Federal Reserve. While governments did not lose money, they did take on risk for these nonbanks.

The "margin call plus contagion" scenario: Borrowing on margin to make bigger bets enhances profits but also raises risks. Some hedge funds and family offices (wealth managers focused on one or more wealthy families) borrow large amounts of money with little collateral to bet on events like stocks or bond price swings. In times of stress anywhere in the financial system, the institutions the nonbanks borrow from often go from requiring too little collateral to requiring too much, amplifying risks for everyone.

If these bets go wrong, the nonbanks may collapse, triggering losses and illiquidity for their creditors and broader market stresses. Such contagion resulted when the Archegos Capital Management family office collapsed in 2021 causing significant harm to large global banks.

Protecting the public

• Get more and better data: Nonbanks borrow heavily from banks and others in the financial system, yet their disclosure and reporting requirements are quite light. Neither market participants nor financial regulators have a comprehensive view of the macro-financial stability risks arising from the sector. Taxpayers are often called in to help out in times of stress, so they deserve to know more about the risks nonbanks take. When transaction information can't be public for competitive reasons, it should be visible to regulators-and shared across borders. The Financial Stability Board's Nonbank Data Task Force is helping increase visibility.
• Use data to improve risk analysis: Regulators can also do more with the data they already have to map connections between banks and nonbanks, and among nonbanks. Using new models and technology can help them gain a better understanding of global financial risks. Leading examples include the Bank of England's System-Wide Exploratory Scenario, first conducted in 2023, and the IMF's recent work on systemwide financial stability risks in the euro area.
• Use risk analysis to strengthen supervision: As risks are better understood,national and international regulators can more quickly spot and intervene forcefully to make global finance less vulnerable to shocks.

Bottom line

Nonbanks are a diverse group. We need to better understand their activity and ensure that their riskiest activities are appropriately regulated to reduce potential risks to the financial system and economic activity, while allowing space for dynamism and innovation in the provision of financial services.

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