Adapted from “The Secular Decline of Bank Balance Sheet Lending,” by Greg Buchak of Stanford University Graduate School of Business, Gregor Matvos of Northwestern University Kellogg School of Management, Tomasz Piskorski of Columbia Business School, and Amit Seru of Stanford University.
Key Takeaways:
- The share of private lending made up of bank balance sheet loans declined from 60 percent in 1970 to 35 percent in 2023.
- In its place, alternative financing structures, including debt securities, have overtaken the credit industry.
- Because of this shift, regulators can afford to impose greater capital requirements on the banking industry — and should consider turning their attention to non-bank financing structures as well.
To the average American, the idea of banking is simple: You deposit money into a bank account, and, in return for being able to use your money while it’s in that account, the bank pays you a small amount of interest that accrues over time. And if you want to borrow money for a car or home improvement project? The bank lends you some of the cash it’s holding on to.
This type of lending is called a balance sheet loan, which, traditionally, has largely been offered by small- and mid-sized banks.
But issuing this type of debt is inherently risky for a financial institution. “Traditional banks finance themselves 90 percent with debt, and even a small, modest decline in asset values of banks can, in principle, put them in a situation in which they are insolvent,” says Tomasz Piskorski, the Edward S. Gordon Professor of Real Estate at Columbia Business School.
Because of that, the American financial regulatory system is deeply focused on traditional banks. “Regulators are working on the premise that traditional banks are incredibly important for the provision of credit,” Piskorski says. “The idea is, if the banks are in trouble, people won't be able to get the auto loans or credit cards; businesses won't be able to get loans to do construction, to invest and grow.” And because traditional bank deposits are insured by the Federal Deposit Insurance Corporation (FDIC), regulators have particular interest in making sure the banks stay solvent.
But traditional bank balance sheet lending is increasingly being replaced by alternative financing structures that rely on debt securities and other investment vehicles. Those investments are not insured by the FDIC or regulated in the same way. So, what if traditional lending isn’t as essential to the US credit system as regulators believe? And what if banks could be regulated without drastically changing the credit landscape? Piskorski and his co-researchers sought to investigate the share of lending that is still bank sheet loans and what the shift away from traditional banking will mean for regulators moving forward.
How it was done: Piskorski and his co-researchers documented and analyzed banking trends from the 1970s to 2023, observing the share of lending that was financed through bank balance sheets as opposed to non-bank financing. They then developed a structural model to explore whether factors such as technological improvements in securitization, shifts in saver preferences away from deposits, and changes in implicit subsidies and costs of bank activities could explain those shifts. They also examined the potential impact of greater regulation on traditional banks.
What the researchers found: The research shows a seismic shift in the banking landscape in the United States. In analyzing banking trends, the researchers found that the share of private lending made up of balance sheet loans has declined from 60 percent in 1970 to 35 percent in 2023. “That means that close to two-thirds of credit to households and firms is not financed by banks,” Piskorski says. “They’re financed by people buying debt securities directly, by exchange-traded funds, by private credit, and by money market and mutual funds. Their next step, then, is to understand why it happened — why the banks lost so much importance in funding credit to households and firms.”
The team found two essential factors in this shift. The first was the technology of securitization. “Nowadays, when you get a credit card or mortgage from JPMorgan or Bank of America, you might be thinking Bank of America keeps your loan on a balance sheet,” Piskorski explains. “But in reality, your credit card or mortgage might have been sold in a securitization deal, and those people actually finance your credit. It's not a bank. It's savers that indirectly or directly buy these securities as opposed to financing them though a traditional bank deposit channel.”
The second factor was the development of demand for diverse and higher-yield assets. “In the good old days, when you were saving money, you were just keeping money in a bank,” Piskorski says. “Nowadays, people have many more alternatives to save money. For example, they can put them in a money market fund. And money market funds are not typically run by banks. They are run by companies like Blackrock. They don't take deposits, and they will invest your money into securities or loans, essentially replacing traditional banks.”
Finally, the researchers found that because of these shifts, the credit landscape is not as delicate as regulators might believe — meaning regulators could increase capital requirements for traditional banks without severe economic consequences.
Why it matters: The research shows that regulators’ attention may be misplaced in the banking industry. “I know we care about banks because we implicitly insure them through the FDIC as taxpayers, but in reality, they're not as important as we think. They account for a minority of credit financing to households and firms.”
“In other words, we should ask banks to be less debt-funded,” Piskorski says. “They're just too risky. They take on too much debt. If you talk to bank CEOs, they will tell you, ‘Oh, yeah, sure, if you ask us to keep more capital, we will be safer. We'll be less likely to go into default. But we will have to cut lending to households and firms on our balance sheets.’ And we're essentially saying that's really not that important, since there are alternative ways to finance lending and such lending would expand.”
This means that the government could more aggressively regulate banks, ensuring that they’re less likely to face insolvency risk, without making significant economic sacrifices. Additionally, Piskorski says regulators should consider turning their attention to the non-bank financing structures. “If anything, the regulators should be more obsessed about that — securities markets, private credit, the non-bank sector — because this is how most of the lending activity is financed nowadays.”
