Out of the shadows

In theory, this is a great time for Europe’s nascent shadow banks. With banks in retrenchment mode and bond markets only open to large companies, there should be plenty of opportunities to lend profitably to solvent medium-sized companies. Some fund managers are indeed stepping in and raising credit funds which lend directly to companies. But these are likely to remain a niche product, particularly in Europe’s periphery.

It’s no secret that small and medium enterprises are having trouble getting funding from banks. One third of SMEs across Europe did not get the finance they had planned for in the last year, according to a European Commission survey. Government agencies can help, such as Spain’s Institute of Official Credit and the European Investment Bank - but sovereigns can’t pick up all the slack.

Investors such as Bluebay Asset Management, Haymarket Financial and Palio Capital, are stepping in as banks retreat. Estimates are hard to come by, but one manager believes non-bank lenders have raised at most 2 billion euros, still a drop in the ocean compared to outstanding SME loans.

There’s a limit to how easily these new lenders can replace the banks. Unlike banks, credit funds don’t tend to use leverage, and don’t play the yield curve (borrowing cheaply at short maturities, longer-term lending at higher rates). For the new European shadow banks to earn the kind of returns they promise investors - typically high single-digit or double-digit percentage points - they have to target borrowers that can afford to pay more, for example companies that are geared up by private equity firms, or which are growing quickly.

Moreover, most of the funds are focused on the UK and northern Europe. Spain and Italy are tough for them, partly because they would need to charge a high premium over already elevated sovereign bond yields, making loans prohibitively expensive for borrowers.

Also, borrower-friendly insolvency laws in France and Spain are a turn-off. And the lenders worry about the economic environment - GDP in both Italy and Spain is expected to shrink this year. Non-bank lending can help deal with the credit crunch, but in the periphery where banks are under most pressure, it will only be at the margin.