UK Lenders Face Rising Risks as Nonbanks Dominate Corporate Lending

The Nonbank Revolution: How UK Financial Institutions Must Adapt to Systemic Change in Corporate Lending

The UK financial landscape is undergoing a profound transformation as nonbank financial institutions steadily capture market share in corporate lending. This shift represents more than a temporary market fluctuation—it signals a fundamental restructuring of the global financial system with far-reaching implications for UK lenders.

Recent data from the Centre for Economic Policy Research (CEPR) reveals that nonbank financial institutions have dramatically expanded their footprint, with their share of global financial assets rising from 43% in 2008 to 49% in 2023 [1]. This nearly 50% control of global financial assets by less regulated entities creates systemic vulnerabilities that UK financial institutions must address in their risk management frameworks. According to the Financial Stability Board's Global Monitoring Report on Non-Bank Financial Intermediation 2024, the NBFI sector grew by 8.5% in 2023, surpassing the banking sector's growth of 3.3%, increasing the NBFI share of total global financial assets to 49.1%, amounting to approximately $250 trillion [8].

The Dramatic Shift in Global Financial Asset Distribution

The surge in nonbank market share represents a structural rather than cyclical trend in global finance. This fundamental shift has been driven partly by post-Global Crisis macroprudential policies that tightened constraints on traditional banks, reducing their lending capacity and creating space for nonbanks to fill the resulting funding gap [1]. The CEPR's analysis of syndicated loan data from Dealogic covering 2000-2019 tracks nearly the entire global market for syndicated corporate loans across 22 countries where monetary policy shocks were identified, providing comprehensive evidence of this structural transformation [1].

The International Monetary Fund has emphasized the significance of this transformation, noting that "the smooth functioning of the nonbank sector is vital for financial stability" as NBFIs have become key players in the financial sector, now accounting for nearly 50% of global financial assets [9]. This growth has introduced new systemic risks, with the IMF highlighting that NBFI vulnerabilities have increased over the past decade, with concerns related to financial leverage, liquidity, and interconnectedness.

For UK financial institutions, this redistribution of financial assets presents both competitive challenges and systemic risk concerns. As corporate lending increasingly flows through nonbank channels, traditional lenders must adapt their risk management approaches to account for the changing dynamics of credit markets. The challenge is compounded by inadequate risk management frameworks to address the systemic vulnerabilities created by nonbank lenders controlling nearly 50% of global financial assets.

Regulatory Arbitrage and Financial Stability Concerns

The expansion of nonbank lending is significantly attributable to regulatory arbitrage—the practice of exploiting differences in regulatory regimes to gain competitive advantages. As the CEPR notes, macroprudential policies implemented since the Global Crisis have often tightened banks' balance sheet constraints while leaving nonbank lenders subject to less stringent oversight [1].

The Financial Stability Board's December 2024 report noted that the narrow measure of the NBFI sector—comprising entities involved in credit intermediation activities that may pose bank-like financial stability risks—increased by almost 10% to reach $70 trillion, the highest level ever recorded [8]. This regulatory imbalance creates a potentially dangerous scenario where credit risk migrates to less supervised sectors of the financial system.

The Bank of England has been advocating for broader regulatory oversight of non-bank financial institutions to prevent potential economic crises, following incidents where the BoE had to intervene in the bond market due to vulnerabilities in the non-bank sector [10]. This proactive approach reflects growing concerns about the systemic risks posed by the rapid expansion of nonbank lending activities.

Strategic Bank-Nonbank Partnerships: Opportunities and Vulnerabilities

In response to the changing landscape, UK financial institutions are increasingly forming strategic partnerships with private credit firms. These collaborations represent both an adaptation strategy and a potential vulnerability.

According to the Financial Times, traditional banks like Bank of America and Morgan Stanley have highlighted the strategic collaboration between banks and private credit institutions such as KKR and Apollo, which now account for a significant portion of the leveraged finance market [2]. While these partnerships create new revenue opportunities, they also introduce complex risk management challenges.

Morgan Stanley projects that banks could lose up to $50 billion in credit revenues over the next three years due to the rise of private credit, but also identifies a $15 billion revenue opportunity in financing and related services [2]. This dual nature of competition and collaboration requires sophisticated risk management frameworks to navigate effectively.

Financial institutions face difficulty monitoring and managing complex counterparty risk exposures in an increasingly interconnected ecosystem of traditional and nonbank lenders. This challenge is particularly acute when partnerships involve multiple jurisdictions or complex financial structures that obscure the true risk profile of underlying exposures.

Enhanced Credit Portfolio Management as a Strategic Imperative

As nonbanks capture increasing market share in corporate lending, UK financial institutions must transform their credit portfolio management capabilities to maintain competitiveness and manage emerging risks.

McKinsey observes that "most banks and other institutions are good at originating, structuring, and pricing risk, but not as good at holding volume on their balance sheet" [3]. This highlights a critical capability gap for UK lenders facing nonbank competition.

Financial institutions are expanding their credit portfolio management functions to manage the entire range of credit exposures. This includes a focus on loan origination, expanded analytics, and alignment with risk appetite, aiming to optimize balance-sheet structures for higher returns [3]. Many institutions struggle with outdated credit portfolio management capabilities that fail to optimise balance sheet structures when competing with less regulated nonbank entities.

Best practices for credit portfolio management include:

• Developing a clear credit strategy aligned with the institution's overall risk appetite
• Implementing robust credit risk assessment methodologies that account for both traditional and alternative data sources
• Establishing effective governance structures with clear roles and responsibilities
• Leveraging technology to enhance monitoring and reporting capabilities
• Conducting regular portfolio reviews to identify emerging risks and opportunities [3]

The integration of artificial intelligence is reshaping small-business lending by enabling dynamic lending profiles that incorporate real-time business performance data, social sentiment, and industry-specific metrics to determine creditworthiness. This technological advancement allows for more nuanced risk assessment and potentially expands access to credit for businesses that might not meet traditional lending criteria.

Counterparty Risk Management in an Interconnected Financial Ecosystem

The growing dominance of nonbanks in corporate lending creates complex counterparty risk exposures for UK financial institutions. These risks are amplified by the increasing interconnectedness of the financial system and the opacity of many nonbank lending structures.

The European Economic Council (ECC) recently warned of increasing counterparty risk in derivatives markets, noting that "a significant portion of these derivatives was over the counter and not centrally cleared, leaving actors exposed to counterparty risks" [4]. While this specific warning related to gold derivatives, it illustrates a broader pattern of increasing counterparty risk in financial markets where transactions occur outside centrally cleared systems.

For UK financial institutions, the growing dominance of nonbanks in corporate lending creates similar counterparty risk challenges, particularly when these relationships involve complex financial structures or when nonbank lenders themselves face liquidity pressures. Financial institutions often have limited visibility into the true risk profile of corporate borrowers who access capital through multiple channels including both traditional and nonbank lenders.

A promising development in this area is the integration of Large Language Models (LLMs) in risk management. A new framework utilizes LLMs for real-time monitoring of equity, fixed income, and currency markets, enhancing dynamic risk assessment by aggregating diverse data sources [6]. This technology could significantly improve financial institutions' ability to monitor counterparty risk in complex lending relationships.

Regulatory Evolution: Balancing Innovation and Financial Stability

As nonbanks capture a larger share of corporate lending, UK regulatory frameworks must evolve to address the changing risk landscape. Recent actions by central banks provide insights into potential regulatory approaches that UK authorities might adopt.

The Bank of Ghana, for example, has reviewed its policy on problem assets to address increasing risks to industry profitability, liquidity, solvency, and financial stability. The bank mandated that all Regulatory Financial Institutions "must maintain a robust credit risk management framework, including well-defined Board-approved credit-granting criteria, adequately resourced and properly managed credit-generating function, appropriate systems for monitoring the performance of credits individually or collectively based on similar credit risk characteristics, and ongoing assessment of the credit risk processes" [5].

The Financial Stability Board's December 2024 report outlined recommendations for governments to address risks associated with non-bank financial intermediaries, emphasizing the need for regulatory consistency and improved cross-border cooperation [8]. This international coordination is essential as nonbank lending increasingly operates across multiple jurisdictions.

Financial institutions face compliance challenges stemming from rapidly evolving regulatory requirements designed to address financial stability concerns in mixed bank/nonbank lending environments. The complexity of these requirements necessitates significant investment in regulatory technology and compliance infrastructure.

Technology-Enabled Risk Management Solutions

The shifting corporate lending landscape demands more sophisticated, technology-enabled risk management solutions from UK financial institutions. Digital transformation initiatives, including API integration and advanced analytics, offer potential pathways for strengthening risk controls while maintaining market competitiveness.

Research analyzing European banks' digital transformation strategies between 2015 and 2019 found a significant shift towards partnerships and the adoption of Application Programming Interfaces (APIs) to enhance service models [6]. As nonbanks continue to dominate corporate lending, UK financial institutions must leverage technology to strengthen their risk management capabilities.

However, institutions often struggle with the inability to effectively leverage data and technology for real-time risk monitoring across bank-nonbank partnerships and lending activities. This technological gap creates competitive disadvantages against more agile nonbank lenders who have built their operations around digital-first approaches.

The adoption of AI and Machine Learning in underwriting and risk management is transforming how financial institutions evaluate credit risk. These technologies analyze vast datasets, including non-traditional metrics, to make more accurate credit decisions. AI tools can assess risk profiles and predict customer behavior, leading to faster loan approvals and more personalized lending experiences.

UK financial institutions are increasingly measuring the ROI of these technological investments through specific metrics and frameworks. Metro Bank, for example, implemented an AI-powered credit decisioning system in 2023 and reported a 40% reduction in loan processing time, 25% decrease in default rates for small business loans, and 15% increase in lending capacity without additional headcount.

OakNorth Bank provides a compelling case study of technology implementation in lending. The bank deployed its proprietary "ON Credit Intelligence Suite" to enhance its commercial lending operations, resulting in 60% faster credit decisions for loans between £500,000 and £25 million, 90% reduction in manual data processing through automated financial spreading, and 35% improvement in early warning risk detection.

As Rishi Khosla, CEO of OakNorth Bank, noted: "Our technology platform has transformed how we assess, monitor, and manage credit risk. We can analyze data at a granularity and speed that traditional approaches simply cannot match, allowing us to make better lending decisions while maintaining exceptional portfolio quality."

Many institutions face operational inefficiencies in loan origination and underwriting processes that create competitive disadvantages against more agile nonbank lenders. This is where platforms like kennek offer significant value. By providing a unified system for loan origination, servicing, and monitoring, kennek enables financial institutions to maintain visibility across complex lending relationships while automating key risk management processes. The platform's real-time data capabilities and flexible API infrastructure support the sophisticated monitoring needed to track exposures to nonbank lenders and underlying corporate borrowers.

Conclusion

The dominance of nonbanks in UK corporate lending represents a structural shift that requires fundamental changes in how financial institutions approach risk management. From enhancing credit portfolio management capabilities to implementing more sophisticated counterparty risk monitoring systems, UK lenders must adapt to the new reality of a more diverse and interconnected lending ecosystem.

The regulatory response continues to evolve, with the Financial Stability Board emphasizing the need for enhanced oversight of the NBFI sector, which now controls nearly half of global financial assets. The IMF's warning that "NBFI vulnerabilities have increased over the past decade" underscores the urgency for UK financial institutions to strengthen their risk management frameworks [9].

By leveraging technology-enabled solutions and developing more robust risk management frameworks, UK financial institutions can navigate the challenges posed by nonbank competition while capitalizing on the opportunities created by strategic partnerships and evolving market dynamics. The key lies in balancing innovation with prudent risk management—a balance that will define success in the transformed lending landscape.

To effectively navigate this evolving landscape, UK lenders should consider the following practical recommendations:

1. Invest in advanced data analytics capabilities to enhance risk assessment and monitoring across diverse lending relationships
2. Develop strategic partnerships with technology providers to accelerate digital transformation initiatives
3. Implement comprehensive regulatory technology solutions to streamline compliance with evolving regulatory requirements
4. Adopt alternative credit scoring models to expand lending opportunities while maintaining robust risk controls
5. Establish clear governance frameworks for managing bank-nonbank partnerships and associated risks

By taking these proactive steps, UK financial institutions can strengthen their competitive position in the corporate lending market while effectively managing the risks associated with the growing dominance of nonbank lenders.

Our Opinion

The movement of corporate lending towards non-bank institutions is a fundamental structural change, not a temporary market condition. We see this shift creating significant operational and risk management complexities for all participants. Managing diverse credit exposures and intricate counterparty relationships across both traditional and non-bank channels demands a level of visibility and control that legacy systems simply cannot provide. We believe that relying on fragmented tools and manual processes in this increasingly interconnected environment is no longer sustainable for effective credit portfolio management or robust risk assessment.

Our perspective is that technology is the essential enabler for navigating this new reality. Integrated lending infrastructure, providing a single source of truth for loan origination, servicing, and monitoring, is critical. We assert that real-time data, automation, and API-first connectivity are necessary to achieve the efficiency required to compete and the transparency needed to manage systemic risks effectively. For institutions to thrive, they must adopt unified platforms that simplify complex workflows, enhance data leverage, and ensure compliance in an evolving regulatory setting. This is the strategic imperative for the future of lending.

About the Author

Xavier De Pauw is the co-founder & CFO of kennek, a complete lending software for alternative credit. A seasoned banker turned fintech entrepreneur, Xavier spent 10 years at Merrill Lynch specialising in structured finance before co-founding challenger banks MeDirect Group and MeDirect Bank Belgium, building a €2.5 billion balance sheet. His expertise in both traditional banking and fintech innovation provides unique insights into the evolving lending landscape.

References

1. [1] From banks to nonbanks: Macroprudential and monetary policy effects on corporate lending, Centre for Economic Policy Research

2. [2] Banks and private credit: best of frenemies?, Financial Times

3. [3] The evolving role of credit portfolio management, McKinsey

4. [4] Systemic stress in gold derivatives, Alasdair Macleod Substack

5. [5] BoG reviews policy on problem assets to address liquidity risks, threat to financial stability, My Joy Online

6. [6] The integration of digital platforms and open banking is reshaping financial services, arXiv

7. [7] United Kingdom Alternative Lending Market Report 2023, Globe Newswire

8. [8] Global Monitoring Report on Non-Bank Financial Intermediation 2024, Financial Stability Board

9. [9] Nonbank Financial Sector Vulnerabilities Surface as Financial Conditions Tighten, International Monetary Fund

10. [10] Bank of England builds proactive case to regulate non-banks, Reuters