Alternative Finance

Shadow Banks on the Rise

A new dawn breaks over Germany's financial capital Frankfurt. Source: DPA
A new dawn breaks over Frankfurt, Germany's financial capital .
  • Why it matters

    Why it matters

    As investors in Germany contend with record low interest rates, the government is seeking to boost alternative forms of financing.

  • Facts

    Facts

    • German financial regulator Bafin is opening the credit market to investment funds.
    • The funds will increase competition on banks for loans and project financing.
    • State development bank KfW wants to inject €2.5 billion, or $2.64 billion, into the German venture capital scene.
  • Audio

    Audio

  • Pdf

What was announced as a simple administrative change could have a huge impact on Germany’s credit landscape: Financial regulator Bafin aims to make it easier for investment funds to provide loans to firms and financing for infrastructure projects.

The move could open up new sources of financing for small and medium-sized firms in Germany that are looking to expand. But it could also expose the country’s already beleaguered banks to a whole new wave of competition to provide loans to businesses.

The rise of “shadow banks,” as the non-bank credit market is known, has long been viewed with some trepidation in Germany. Investment funds typically aren’t subject to the same stringent requirements as the traditional banks that have long dominated the country’s financial landscape. That makes them more flexible, but also sows fears that a growing and unregulated shadow banking market could leave the system more exposed if another financial crisis comes along.

Despite the concerns, regulators across much of Europe have been busy easing requirements for investment funds to lend money to businesses, hoping the new funding sources can spark a revival of the continent’s economy, which continues to suffer under the weight of a five-year-long debt crisis.

It’s a major headache for banks. With record low interest rates in Europe squeezing profit margins on loans to as low as 1.5 percent, traditional lenders have struggled to earn a living. The new rules will make it easier for investment funds, which aren’t subject to the same stringent requirements as banks, to steal market share away.

Demand for alternative forms of financing is growing among Germany’s small and mid-sized companies, as well as from groups seeking funding for infrastructure projects.

“Bafin’s new administrative practice is a milestone,” said Patricia Volhard from the lawfirm P+P Pöllath + Partner.

Ms. Volhard said credit funds were ideally placed to meet the demand coming from mid-sized firms – unlike German banks, which have been forced to hold back issuing more loans due to legal requirements.

Institutional investors such as pension funds and insurers continue to suffer from Europe’s record low interest rates, making them desperate for new forms of finance

Such funds are designed for large investments and are not able to issue smaller consumer loans. Regulators do require the funds to have certain minimum of liquidity – but not as high as that facing banks.

About 20 such funds exist in Europe, operated largely out of London. Around the world last year, 76 new closed-end funds – funds that issue a fixed amount of shares at their creation – raised around $50 billion, according to PDI Research & Analytics.

The Bafin decision, which will allow credit funds to lend directly to mid-sized firms, could now encourage new ones to be created in Germany as well. Funds have already been anticipating the shift, which Bafin announced in a note to banking associations on May 12.

“We see good opportunities for credit funds in Germany. The recent decision easing financial regulation of credit allocation will simplify our business,” said Ralph Betz, head of the Germany arm of Swedish fund EQT Credit.

He said his deal pipeline, as that of the competition, was already full.

Such credit funds have up until now been something seen more in the Anglo-Saxon finance world, where non-bank financing has long held the upper hand over the more traditional banks that have controlled lending in much of Europe.

“Alternative financiers in the U.S. have a market share of 83 percent, but in the E.U. only 22 percent,” said Frank Dornseifer, director of Germany’s BAI alternative investment association.

However, institutional investors in public funds such as pension funds and insurers continue to suffer from Europe’s record low interest rates, making them desperate for new forms of finance. Yields from private investment funds by contrast are currently between six to eight percent, said Alexander Bode, head of BB Alternative Partners.

 

Company Loans Furnished by Capital Funds-01

 

Moreover, plenty of established small- and mid-sized firms in Germany are eager for loans between €10 million and €150 million from credit funds.

But many startup companies need more than just an alternative to a bank loan, which is why a German development bank is also trying to boost the country’s venture capital market.

State development bank KfW is hoping to mobilize €2.5 billion for the sector over the next five years – that would be quadruple the current sum. The goal is to increase the number of initial public offerings on the stock market by innovative startups.

In order to help expand the German venture-capital scene, KfW is creating a new fund, the ERP Venture Fund, where it hopes to raise €400 million, according to Ingrid Hengster, a KfW board member. That fund, in turn, will be able to invest up to a stake of 20 percent in other funds financing startups. The aim is to unlock five times more private financing in order to secure Germany’s burgeoning high-tech sector.

“What we’re initiating could help create candidates for public listings and a solid stock market foundation,” Ms. Hengster told Handelsblatt.

But she said KfW wanted to avoid creating a startup bubble on the stock market.

“We have to do solid work and make sure no hype is created,” she said.

KfW is also planning to establish a co-investment fund in the fourth quarter of this year with a volume of €225 million. In contrast to the ERP Venture Fund, it will be able to invest directly in firms  and hold up to a 50-percent stake. Private investors will finance the remaining share of the startups. KfW hopes this will mobilize €450 million in total.

While KfW and Bafin attempt to stoke private investment, in remains unclear if the German government will agree to a new legal framework for venture capital.

“We’re working to create an ecosystem like in the U.S.,” said Thomas Jarzombek, parliamentarian spokesman for digital issues from the conservative Christian Democrats.

 

Peter Köhler, Robert Landgraf, Anke Rezmer report for Handelsblatt from Frankfurt and Frank M. Drost and Daniel Delhaes from Berlin. To contact them: Koehler@handelsblatt.com, landgraf@handelsblatt.com, rezmer@handelsblatt.com,drost@handelsblatt.com and delhaes@handeslblatt.com

We hope you enjoyed this article

Make sure to sign up for our free newsletters too!