Shadow banks, according to financial experts, could pose a threat to the global economy

A leading financial expert has warned that the global economy could be jeopardized by the rise of shadow banks and patchy regulatory oversight.

In an opinion piece for the Financial Times, Ruchir Sharma, Chair of Rockefeller International, stated that shadow banks – non-bank financial institutions that provide banking services outside of normal banking regulations – have grown in popularity around the world.

Pension funds, private equity firms, and asset managers are among the shadow banks, which now manage $63 trillion in assets, accounting for 60% of China's GDP.

According to Mr Sharma, China's shadow banking banking sector is "deeply enmeshed in risky lending to local government, property companies and other borrowers." He also revealed that shadow banking assets in Europe's financial centers such as Ireland and Luxembourg are growing at an annual rate of 8-10 percent.

He explained that raising interest rates has previously resulted in a "variety of outcomes" for the economy, but "has always led to financial crises somewhere – including every major global crisis in recent decades."

"Borrowers to watch most closely now are corporations. In the US, corporate debt as a share of assets remains near record highs, particularly for firms in industries hardest hit by the pandemic… A third of publicly traded companies in the US do not earn enough to make their interest payments,"  Mr Sha.ma wrote, "Any increase in borrowing costs will make life difficult for these companies."

He warned that the "realm beyond regulators" is where the next crisis will emerge, and that "risky private corporate borrowers" account for a "substantial chunk" of direct lending from private investors.

"Over the past four decades, as financial markets grew to more than four times the size of the global economy, feedback loops shifted." He went on to say that "markets, which used to reflect economic trends, are now big enough to drive them."

"The next financial crises are thus likely to arise in new areas of the market, where growth has been explosive and regulators have yet to arrive," Mr Sharma warned.

"The even bigger risk, in a heavily financialised world, is that an accident in the markets settles the debate over how hard Fed tightening will hit the real economy," Mr Sharma concluded.

By fLEXI tEAM