Regulators are overlooking the threat shadow banks pose to the economy

Policymakers must "encourage an environment that places fair, sound rules and regulations across the financial sector aimed at protecting people, and banks shouldn't be singled out while regulators turn a blind eye to other major risks in less scrutinized sectors like private credit," Valley National Bank chief Ira Robbins says in arguing that shadow banks pose a bigger systemic threat than most regional banks.

It's disappointing how many inaccurate or false statements about regional banks have been put out in the public sphere since the failures of Silicon Valley Bank and Signature Bank. The reality is that the vast majority of regional banks across the country, including the bank I am proud to lead, are financially sound, managed safely and continue to serve as the financial engine of local economies.  

But somehow analysts and so-called "experts" continue to try and search for other "risks" facing banks, like the notion that the regional banking sector is carrying too much risk in commercial real estate, holding more than 70% of CRE loans. Or, that the American taxpayer is the one footing the bill when banks take on too much risk and fail. Both of which are just not accurate.

Regional banks hold only slightly more than 30% of CRE loans, and it is the banking sector that covers the cost of bank failures through our funding of the Federal Deposit Insurance Corp. — not the American taxpayer.

Inaccurate information here is leading to two troubling things. First, an unwarranted erosion of trust in regional banks. And second, increased banking regulation that will impose new capital requirements on U.S. banks, making lending more challenging in many communities.

What isn't changing, however, is the fact that our economy is still thriving and businesses still need access to capital to grow and succeed. So, when business owners lose trust in their local banks or can't borrow because of increased regulations, they increasingly turn to shadow banks (nonbank financial companies that operate with little to no oversight from regulators) and private credit funds. These are the real risk to the American taxpayer.

Why is that? Since the subprime lending crisis, banking regulators have directly, through increased risk rating and reserves for loan-loss requirements, and indirectly, through enhanced liquidity and capital requirements, facilitated the explosive growth of a shadow banking in the United States.

This dynamic, combined with the low interest rate environment during the last 10-plus years, has enabled the private credit industry to grow from $300 million in 2010 to more than $1.5 trillion today. Yet, the implications of this exponential growth have yet to be recognized. 

Let's begin with the fact that the shadow banking industry is largely unregulated. Private credit funds are largely supported by the investments of wealthy individuals and institutional investors. This has created a perception that if something were to go wrong with a private credit fund these wealthy individuals and investors would bear the cost of these losses and not the taxpayer. But, in reality, there is a major indirect cost to the taxpayer hiding under the surface.

As of today, more than 30% of funding for private credit funds come from public pension funds, not private corporate pension funds or even private endowments. These funds largely make up retirement savings for local municipal workers such as police officers, firefighters and teachers. Ironically, it is the public pension funds that can least afford to invest in riskier private credit funds. Most are already largely underfunded (on a relative basis compared to private pension funds). Any underfunding or investment loss in public pension funds is ultimately paid for by the American taxpayer through increased taxes at the local level or bailouts at the federal level.

I commend regulators and government officials for attempting to ensure a safer banking environment. I am not a bank CEO that is against regulation. I am, however, someone who wants to see regulation and rules applied evenly and fairly to keep people safe — from banks to private credit funds. If you want to operate like a bank and offer banklike services, you should meet the same tough standards as banks.  

Right now, I'm encouraged by some of the decisions being made by the Securities and Exchange Commission to institute a rules package that would bring greater transparency and increase liability for mismanagement or negligence to private credit funds. But I'm also disheartened by the funds pushing back, trying to keep this veil of secrecy over their business practices and potentially hiding great risk to so many people's livelihoods.

I believe we need to continue to encourage an environment that places fair, sound rules and regulations across the financial sector aimed at protecting people, and banks shouldn't be singled out while regulators turn a blind eye to other major risks in less scrutinized sectors like private credit. Unlike with the banking sector, there is no FDIC that will come in and protect investors from potential losses at shadow banks. And with so much of our public pension funds in the hands of these private credit funds, the ultimate cost of failures in private credit will be indirectly paid for every day, by hardworking American taxpayers.

Let's stop searching for mythical risks in the banking sector and finally shine some light on the very real threats lurking in America's shadow banks.