The rapid growth in lending by U.S. banks to non-bank financial institutions raises the likelihood of lurking credit problems in the U.S. banking sector — and intensifies the need for tougher underwriting and risk management practices, says Fitch Ratings.
In a report published Monday, the rating agency said the recent losses reported by U.S. banks involving loans to non-banks, including consumer credit and commercial mortgage firms, may signal growing risk amid the strong growth of bank lending to these kinds of firms.
“While these cases may be fraud-related and idiosyncratic, rapid expansion of NBFI exposures increases the chance that concentrated counterparties, combined with weak underwriting, could pressure bank earnings and sentiment beyond individually affected banks,” Fitch said.
Recently, a handful of U.S., including JP Morgan Chase, Fifth Third, Zions Bancorp and Western Alliance have disclosed losses on loans to non-banks.
“These losses highlight the interconnectedness between the NBFI sector and the regulated banking system, and that weaknesses in the former can created outsized earnings impact in the latter,” the report said.
The prospect of further issues is compounded by the robust growth in lending to non-banks, which now represents about 10% of total loans, up from 3% a decade ago, Fitch said.
“Growth averaged about 11% annually on a [compound annual growth rate] basis for the entire industry; however, banks with assets between US$10 billion and US$250 billion in assets grew the fastest at roughly 35% during this period,” it noted.
Against that backdrop, Fitch said the size and pace of loan growth to non-banks “heightens the need for tighter underwriting, enhanced borrower due diligence, and strong risk management practices.”