<div id="readability-page-1"><div> <div><figure> <img width="740" height="493" src="https://imageproxy.pbkrs.com/https://arizent.brightspotcdn.com/dims4/default/cdd009c/2147483647/strip/true/crop/5000x3332+0+0/resize/740x493?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" original-src="https://imageproxy.pbkrs.com/https://arizent.brightspotcdn.com/dims4/default/cdd009c/2147483647/strip/true/crop/5000x3332+0+0/resize/740x493"/> <div> <figcaption>From private credit to stablecoins, firms with scant oversight have been allowed to gobble up business that formerly went to regulated banks. Until balance is restored, the system is overburdened with risk, writes Gene Ludwig.</figcaption><p>Graeme Sloan/Bloomberg</p> </div> </figure></div> </div><p>The chickens are finally coming home to roost, and they're making quite a mess. Since Dodd-Frank, if not earlier, <u>nonbank financial institutions have been free</u> to engage in nearly every kind of <u>financial activity imaginable</u>, typically without the guardrails that govern traditional banks. Unless they were caught outright cheating consumers — and sometimes even then — they've largely escaped serious scrutiny. The Consumer Financial Protection Bureau, for its part, spent far too much time fixated on banks and far too little on the fast-growing nonbank sector. The result is a regulatory imbalance that has allowed nonbanks to quietly sweep the money off the Monopoly board and take another lap around &#34;Go.&#34;</p><p>This is not to say that all nonbanks are poorly managed, including from a safety and soundness perspective. But it is to say there is a serious structural imbalance in our financial system — one that creates a great deal of risk.</p><p>The nonbanks' &#34;Get Out of Jail Free&#34; card has put tremendous pressure on tightly regulated banks and allowed nonbanks to expand dramatically. Banks saw their ability to engage in leveraged lending effectively capped, while nonbanks rushed in to seize that lucrative market. They also faced no real limits on experimenting with digital finance, while banks were largely sidelined or effectively punished for trying. And while it's hard to prove, some believe that certain nonbanks profited handsomely by shorting bank stocks and fanning the flames of the 2023 internet-driven deposit runs with rumors that bank deposits weren't safe. As if that weren't enough, nonbanks have been free to lend, trade, and invest with virtually no capital charges, no stress tests, no &#34;living wills&#34; (a time-consuming exercise banks know well), and none of the ever-growing capital requirements, delayed merger approvals, or new-activity applications that have made much of bread-and-butter banking uncompetitive.</p><p>Today, however, the playing field is no longer just tilted, it's completely out of whack. <u>Private credit is rapidly consuming the bank lending market</u>, totaling <u>$1.34 trillion in the U.S. and nearly $2 trillion globally</u> in 2024. Unburdened by the capital requirements, examinations and supervisory constraints that weigh on banks, nonbanks have expanded aggressively into areas once dominated by regulated lenders. Some banks have themselves funded opaque lending funds just to stay in the game. Many worry this growing web of bank funding for shadow lenders, and the complex structures behind it, echo the patterns that preceded the global financial crisis. Is this what regulators mean by safety and soundness? Does this protect the banking system — or the broader economy — or does it undermine both?</p><p>As if this weren't enough, another threat is on the march: stablecoins. Some nonbanks are now moving to disintermediate banks from their most fundamental roles — safeguarding deposits and serving as the backbone of the financial system's payments infrastructure. The simple-sounding term &#34;stablecoin,&#34; which emerged in the 2010s, refers to a digital asset designed to hold a steady value, backed by reserves now defined under the GENIUS Act.</p><p>But its reach today is anything but simple. There are currently hundreds of versions — <u>up to 259 active stablecoins</u>. The largest two, issued by nonbank companies, are pegged to the U.S. dollar and maintain this peg through reserves backed by instruments such as Treasury bills, money market funds, cash or cash equivalents. Yet for all their variety, until recently these instruments existed in a regulatory gray zone that blurred the line between banks and nonbanks.</p><p>As the list grows longer, so does the real problem. It's not whether a stablecoin is truly stable — that may be a problem for some — but that every new coin, stable or not, chips away at the traditional deposit base. These coins can serve, often effectively, as (1) instantaneous payment tools; (2) &#34;safe&#34; stores of value; and (3) convenient units of account — essentially, a substitute for fiat currency. And so, as stablecoins gain broader acceptance, they become not just a substitute for fiat currency but a functional substitute for deposits. When customers buy stablecoins, they move money out of their bank accounts into a digital &#34;wallet&#34; or similar vehicle outside the banking system. And just like that, they have an equivalent — one where the money may never find its way back into the banking system. The bank has been disintermediated.</p><p>Some of this activity, at least in the U.S. and Europe, is regulated to one degree or another. The GENIUS Act, signed into law this year but not expected to be fully implemented until early 2027, puts regulators in charge of setting at least some of the rules of the road. However, in truth, the level of scrutiny will depend upon what the regulators do — or don't do — and, hopefully, the size, scale and type of stablecoin issuer involved. Outside the U.S. and Europe, however, the picture is far less clear, and in many jurisdictions, stablecoin issuers go virtually unregulated.</p><p>It's high time we adopted a clear standard — nationally and through Basel, internationally: &#34;same activity, same size, same regulation.&#34; Some bank regulators are already working toward this goal: a fairer and more balanced system of financial services supervision. Bravo to them. But legislation is likely needed to finish the job. We must level the playing field before more risk seeps into the system and safety and soundness collapse under the weight of these imbalances.</p><p>Allowing nonbanks to continue expanding under lighter rules will, sooner or later, reap the whirlwind for the U.S. economy and the banking industry alike. And when the next crisis forces policymakers to &#34;rise above their principles&#34; and bail out nonbanks, at a minimum, we will have learned our lesson — at a very steep price.<br/></p></div>

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<p>Nonbank financial firms, with minimal oversight, have expanded into areas traditionally dominated by banks, creating systemic risks. These firms, involved in private credit and stablecoins, operate without the regulatory constraints faced by banks, leading to a structural imbalance in the financial system. This expansion pressures banks and raises concerns about financial stability, echoing patterns seen before the global financial crisis.</p>

BankThink Nonbank financial firms have been running wild. A reckoning is coming