Today's Hottest Banking Trend: Lending to Other Lenders

A growing trend in the banking sector involves traditional banks lending money to nonbank lenders, such as private equity firms, fintech companies, and alternative financing institutions. This strategy allows banks to earn steady returns while nonbank lenders use the funds to make higher-risk loans. The shift reflects banks’ efforts to stay profitable amid regulatory constraints and changing market dynamics, making “lending to lenders” one of today’s most talked-about financial moves.

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Financing for nonbank firms is helping banks sustain loan volumes and boost income from trading operations. Banks are once again facing difficulties in expanding their loan portfolios, but they’ve found a solution - providing capital to nonbank financial entities.

Earnings reports from major global and domestic banks show a similar trend: sluggish growth in overall lending. The average annual loan growth across eight commercial banks, from giants like JPMorgan Chase to smaller players like First Horizon, is effectively flat. Many continue to reduce their exposure to commercial real estate lending.

However, one lending category showing strong momentum is funding to nonbank entities, often facilitated through banks’ trading divisions. These include loans to hedge funds, credit-focused investment firms, and other financial companies that extend loans to businesses and consumers. Banks are financing these institutions and at times assist them in packaging and selling the loans to investors via securitization.

At Bank of America, total average loans rose 4% year over year in Q1. Growth in its retail and global banking segments was just 1%, while its global markets division saw a notable 19% increase in lending. Chief Financial Officer Alastair Borthwick noted on Tuesday that the expansion in global markets was broad-based, including asset-backed lending, mortgage-related warehousing, credit facilities, and subscription-based financing.

This kind of lending is also boosting revenue from banks’ trading divisions, where much of this activity is reported. Goldman Sachs revealed record performance in its fixed-income financing operations during the quarter, attributing it to strong mortgage and structured finance lending.

Private funds use subscription credit lines to borrow against pledged capital from their investors. These facilities are becoming more common as funds take longer to sell legacy assets and secure new investments.

By offering financing to these nonbank lenders, traditional banks are effectively supporting large alternative asset managers that compete with them by offering private credit and equity funds. For the largest banks, this exchange often pays off. Although these loans yield less, they are typically well-secured, making them less risky in the eyes of regulators. This allows banks to allocate more capital toward potentially more profitable activities like trading.

Regional banks without trading operations may find it harder to maintain past levels of profitability, as they lack the tools to benefit from this strategy.

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Source: WSJ‍