Can You Ever Actually De-Risk The Banking System?

Episode Summary

Executive Summary: The episode examines whether financial risks that move out of banks into private credit and other shadow-banking structures really stay outside the regulated banking system. Guest Stephen Kelly argues that banks remain central through funding, prime brokerage, reputational ties, and leverage needs, while insurers and retail wrappers are extending private credit’s reach. The conversation also touches on regulation, liquidity transformation, and stablecoins.

Main Topics: Can bank risk really be de-risked? (Priority: 5/5): The hosts and guest debate whether moving loans and credit risk out of banks genuinely reduces systemic risk or simply relocates it into bank-adjacent entities that still depend on banks for leverage and liquidity. How private credit is funded (Priority: 5/5): Kelly explains that investor money entering private credit generally still flows through bank accounts and that the key scarcity is long-term locked-up capital, not raw deposits. Leverage, liquidity, and the 'bank-like' evolution of private credit (Priority: 5/5): Private credit funds are beginning to adopt leverage and evergreen/interval structures, making them resemble banks more closely while still trying to preserve an illiquidity premium. Historical parallels with the 2008 crisis (Priority: 4/5): The discussion compares today’s structures with pre-crisis shadow banking, emphasizing that Bear Stearns and Citi-sponsored vehicles were brought back onto bank balance sheets for reputational reasons. Regulatory response and supervision (Priority: 4/5): Regulators in the U.S. and abroad are probing banks’ exposures to private credit and prime brokerage, though current efforts are mostly information-gathering and tighter supervision rather than direct intervention. Insurance as a funding advantage (Priority: 4/5): The conversation highlights insurers, especially Apollo’s Athene, as a sticky and powerful source of long-term capital for private credit, potentially creating a bifurcated market. Stablecoins and payment infrastructure (Priority: 3/5): In the closing segment, Kelly argues that stablecoin technology may be useful, but the product itself is less compelling than bank deposits for the payment system.

Key Arguments: Private credit does not truly remove deposits from the banking system; it mostly reallocates them within bank accounts and financial intermediaries. The real constraint on private credit growth is the limited supply of equity/locked-up capital willing to fund illiquid assets, unlike banks’ ability to create deposits. Private credit is becoming more bank-like through leverage, evergreen funds, and retail access, which may reduce the distinction between shadow banking and traditional banking. Historical shadow-banking episodes show that risks often return to banks through reputation, sponsorship, or balance-sheet support. Regulators are currently increasing scrutiny through stress tests and data collection, but the main effect so far is to make bank participation in these structures more costly. Insurers provide unusually sticky long-term funding and may become the main edge for large private-credit platforms. Stablecoin rails may be technologically useful, but for most users bank deposits remain the superior end product for payments.

Data Points: Private credit fund leverage: 1x to 2x - Kelly says Apollo initially pitched private credit as lightly leveraged, though this may rise as the market matures. Bank leverage: 10x to 15x - Used to illustrate why private credit cannot easily replicate banking-system credit creation with little leverage. Private credit growth: doubled from 2020 to 2023 - Kelly cites rapid expansion as the market became more mature and more competitive. Bank business-loan growth during COVID shock: 25% - Kelly notes banks increased business loans by 25% in the two weeks after the pandemic hit. Bank business-loan growth during COVID shock: half a trillion dollars - Same example illustrating banks’ ability to create deposits quickly without external fundraising. Timeline for bank lending surge: two weeks - The speed of deposit creation is presented as a structural advantage of banks. Apollo's private credit on-balance-sheet lending: $10 billion - Kelly references JPMorgan doing this amount of private credit, described as a small amount relative to its balance sheet. Stock Movers promo length: 5 minutes or less - Introductory ad for Bloomberg’s Stock Movers audio reports. Bloomberg journalist/analyst network: 3,000 - Mentioned in promo copy describing Bloomberg’s global reporting coverage. Private credit deal mix: middle-market loans / refinancings / hung loans - Described as the type of assets and transactions private credit tends to absorb from banks and public markets.

Pivotal Quotes: "Can you ever really de-risk the banking system?" — Joe Weisenthal: The episode’s central framing question about whether moving risk off bank balance sheets actually reduces systemic vulnerability. "There is no shadow bank without a bank." — Stephen Kelly: Kelly’s core argument that private credit and other non-bank structures still depend on banks for accounts, leverage, and infrastructure. "The long arc of financial history bends towards banks." — Stephen Kelly: Kelly’s view that private credit is gradually adopting bank-like features such as leverage and liquidity wrappers.

Implications: Private credit may expand, but it is unlikely to fully escape the banking system. Expect more regulatory scrutiny, more bank-like product design, and continued dependence on insurers, prime brokerage, and bank infrastructure.