Just days after UBS said that it would gut its fixed-income trading business last October, three of the Swiss bank's senior executives left to launch a firm to go where big banks won't anymore.
The fund, called Melody Capital Partners, is raising about $750 million to make loans or buy debt of companies and other entities with bad credit or no credit rating. Often the borrowers are in financial distress and the financing arrangements tend to be unusual in nature.
For instance, Melody recently lent tens of millions of dollars to a private-equity fund that wanted to buy more shares of a company it already had a stake in, but had all its capital tied up in other investments. Melody also hunts for cash-starved companies that have collateral to seize if loans go bad in industries ranging from telecommunications to real estate.
Once, such risky but lucrative deals fattened the profits of Wall Street banks, including UBS, Goldman Sachs Group, and Deutsche Bank.
But five years after the collapse of Lehman Brothers turned a mortgage crisis into a full-blown financial panic, banks are pulling back their balance sheets from the fringes of the credit markets, with more and more risk being driven to unregulated lenders that comprise the $60-trillion "shadow-banking" sector.
Fragmented and opaque, shadow banking comes in many forms — from payday loans and “crowdfunding” websites on Main Street, to securitised products, money-market funds and repurchase agreements on Wall Street.
Banking regulators traditionally paid little attention to it, but when Lehman went under, shadow banking intensified the tumult: Money markets and repurchase markets seized up, and investment banks and major corporations suddenly had trouble funding themselves. The financial sector, which had spent years trying to avoid regulation, began begging for government rescues.
Rulemakers acknowledge they need to fix the shadow banking sector as they reform the financial system. But their progress on that front has been halting, while regulation for the conventional banking sector has ramped up quickly and severely. In interviews, regulators, bank executives and academics said the increasing regulation of the big banks may be spurring growth in shadow banking, which in turn could be sowing the seeds for the next financial crisis.
“We haven't done as much as we should to fix this,” said former US treasury secretary Henry Paulson, who recently reissued his 2011 book On the Brink with a new prologue that among other things speaks to the risks in shadow banking.