By: TLB Contributor: Susanne Posel
According to the Consumer Financial Protection Bureau (CFPB), the shadow banking industry (SBI) is largely unregulated and functions outside of proper oversight and accountability.
The CFPB estimates that the $46 billion payday loan or cash advance industry has no oversight, refuses to give full disclosures of interest and fees involved, and takes an annual percentage of an excess of 300% against borrowers.
For the first time the CFPB has suggested regulating the SBI because of their dubious practices and products.
The SBI refers to a loan of $500 or less wherein the borrower “provides a personal check dated on their next payday for the full balance or give the lender permission to debit their bank accounts. The total includes charges often ranging from $15 to $30 per $100 borrowed. Interest-only payments, sometimes referred to as rollovers, are common.”
The Consumer Federation of America (CFA) counts 32 states in the US that “permit payday loans at triple-digit interest rates, or with no rate cap at all.”
Shockingly 80% of payday loans are rolled over within 14 days while an estimated 50% of these loans are “in a sequence at least 10 loans long.”
David Silberman, associate director for market research and regulation explained: “Our research has found that what is supposed to be a short-term emergency loan can turn into a long-term and expensive debt trap.”
In 2014, Federal Reserve Governor Jeremy Stein spoke to economists at an American Economic Association (AEA) conference on the subject of the SBI that has created to temperament for a run on the banks.
Stein said this SBI was integral to the crash in 2007 that has cost the US a stable economy.
The central banker said: “Shadow banking money is much more run prone than bank money. A stable deposit franchise gives a bank the ability to ride out transitory valuation changes of the sort that might come from noise-trader shocks or fire sales, without being forced to liquidate assets at temporarily depressed prices.”
Indeed Stein asserted that “banks have government insurance for the deposits they hold and are relatively well capitalized compared to other financial institutions thanks to the regulation that comes along with that insurance. It’s other financial institutions, generally called shadow banks that are much more prone to runs.”
Government handouts, deposit insurance and a reliance on digital transactions have developed the pathway we are on now.
This shadow banking has taken alternative forms such as:
• Advanced check cashing stores
• Crowd-funding websites
• Money-market funds
• Repurchase agreements
Stein pointed toward the unregulated nature of the SBI culture.
Stein said that “part of the reason for this instability is that non-bank financial institutions often give investors the option to seize collateral in a transaction at a moment’s notice.”
Most recently, at the 2015 Annual World Economic Forum (WEF) at Davos bankers spoke about the SBI as having benefited from the financial crisis with yields of 30% in gains and assets.
This industry “played a very important role in cleaning up toxic assets, helped AIG get back on its feet faster, helped European banks help clean up toxic assets.”
Because of regulators pressuring the banking industry, shadow banking has assisted in making other mainstream banks “look better”.
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