Atlanta Fed President Raphael Bostic echoed the concerns of many prominent economists by saying Tuesday that he is concerned about the systemic risk associated with leveraged lending.
“It’s growing fast,” Bostic warned.
Leveraged lending, in which an institution originates a high debt-to-EBITDA corporate loan to finance a large transaction, has been flagged by former Fed Chair Janet Yellen amid deteriorating conditions in the market for corporate debt.
Bostic specifically pointed to leveraged lending that lives outside of the banking industry (nonbank), where bank regulators like the Federal Reserve can’t supervise or regulate activity.
Other prominent current and former regulators have expressed similar qualms about risks in nonbanks; current Federal Deposit Insurance Corp. Chair Jelena McWilliams said mortgage servicers are a potential source of systemic risk while former Fed Chairman Ben Bernanke warned that the central bank needs expanded “lender of last resort” authorities to quickly address the failure of a systemic firm that may not be a bank.
Speaking at a Bank Policy Institute conference in New York, Bostic talked about the state of financial regulatory policy and payments systems alongside Kansas City Fed President Esther George and Chicago Fed President Charles Evans. Responding to a question about whether or not current regulations are perceived as “adversarial” by the industry, Bostic said he saw value in keeping safeguards from the next financial crisis.
“We need to be engaging more with the banks we oversee to make sure they are as sensitive to risk as we are,” Bostic said. “To make sure we don’t have a repeat of that experience.”
Morgan Stanley published a note Monday similarly expressing concern over non-financial corporate leverage, which its analysts described as the “biggest threat to the economy currently.” Estimating a 30% chance of a recession in 2020, Morgan Stanley wrote that leveraged lending is more likely of a trigger than household credit.
Bank CEOs speaking at the conference did not speculate on what may end this extended period of economic recovery, but appeared to acknowledge that the U.S. is running close to the end of the cycle. Bank of America (BAC) CEO Brian Moynihan said the economy “will slowdown.” Bank of the West CEO Nandita Bakhshi agreed, but said conditions still appear fine for the time being.
“We are expecting a downturn and we are gearing up for it but so far so good,” Bakhshi said.
Brian Cheung is a reporter covering the banking industry and the intersection of finance and policy for Yahoo Finance. You can follow him on Twitter @bcheungz.