In recent decades, the financial system -both global and local- has evolved beyond traditional regulatory frameworks. One of the most relevant phenomena in this process is the growth of shadow banking. shadow banking or shadow banking system: a network of financial intermediaries that operate outside the conventional regulatory framework, such as the one established in Chile by the Financial Market Commission (CMF). Its expansion is closely linked to the sustained increase in private debt in developed and emerging economies, including Chile.

What is Shadow Banking?

The shadow banking refers to a set of non-bank non-bank financial institutions that perform functions similar to those of traditional banking -such as granting credit-, but which -such as extending credit, but without being without being subject to the same regulation and supervision.. They include:

• Investment Funds and Special Purpose Vehicles (SPV)
• Leasing companies leasing
• Pension funds and insurance companies
• Fintech that provide loans

These entities raise funds in the market and channel them into credit, often assuming higher risks and without the capital or liquidity requirements demanded of banks. This lack of visibility is what gives rise to the term "shadow banking".shadow"or "shadow banking"..

Global growth of Shadow Banking

Following the 2008 financial crisis, the traditional banking system was subjected to stricter regulation, including the implementation of Basel III. implementation of Basel IIIaimed at strengthening risk management. These measures limited banks' ability to extend credit and made lending more expensive, leading many to seek financing in the unregulated sector.

According to the Financial Stability Board (FSB), by 2023 shadow banking accounted for nearly 50% of global financial assets, and its share continues to grow.. In emerging markets, such as Asia and Latin America, this growth has been particularly accelerated, driven by economic dynamism, low banking penetration and advances in financial technologies.

Private Debt

The rise of shadow banking has gone hand in hand with a sustained increase in non-financial private sector debt. According to the International Monetary Fund (IMF) and the Bank for International Settlements (BIS), this debt has reached historic levels in many economies. In China, for example, it exceeds 200% of GDP, driven largely by parallel financing channels.

Situation in Chile

Despite having a sound and regulated financial system, Chile has seen a steady growth in shadow banking. shadow banking over the last decade. Among the most active players are:

• Fund managers, factoring companies factoring companiesprivate investment funds and fintech and credit fintechs.
• The presence of private lenders has also increased in areas such as factoring, housing debt, real estate project finance and landbanking. landbanking.
• Private debt funds have grown significantly: between 2017 and the end of 2024, invested capital accumulated a compound annual growth rate (CAGR) of 23%. In the case of real estate debt, that growth was 38%.
• In contrast, bank loan portfolios have shown real declines; for example, in April 2024 they decreased by -1.8% year-on-year, despite a positive economic environment.
• For its part, the debt of the private sector -companies and households- has continued to increase. By 2024, household debt exceeded 50% of GDP, driven by mortgage and consumer loans.

Risks and challenges

The growth of shadow banking and private debt entails significant risks:

• Lack of transparency: The opacity of the sector makes it difficult to assess systemic risk.
• Insufficient regulation: Many countries lack adequate regulatory frameworks for these entities.
• Risk of contagion: Although they do not handle guaranteed deposits, their link to traditional banking can amplify financial crises.

In Chile, part of these risks are being addressed with the recent entry into force of the Fintech Law, which seeks to improve the supervision and transparency of the sector.

Private Debt as an investment alternative

In addition to offering financing outside the banking system, private debt has established itself as an attractive option for investors seeking to diversify their portfolios. an attractive option for investors seeking to diversify their portfolios..

This type of asset has gained space in portfolios, as it allows for a favorable favorably shifting the efficient frontier of a traditional 60/40 allocation (60% equities, 40% fixed income), thanks to its combination of attractive returns of a traditional 60/40 allocation (60% equities, 40% fixed income), thanks to its combination of attractive returns and lower expected volatility.

Private debt includes inflation-linked instruments, with acyclical behavior, real asset backing and a wide variety of maturities: from 30-day bills to leasing to 40-year housing leasing.

DISCLAIMER

José Pablo González

Portfolio Manager Private Debt Fynsa AGF