In a recent report, the Federal Reserve Bank of St. Louis detailed the size of the non-depository financial institutions (NDFIs) sector and the level of exposure traditional banks have to it. As of first-quarter 2025, according to the St. Louis Fed, U.S. banks held $1.14 trillion in loans outstanding to NDFIs, whose products are not only funded by banks at times, but can also sometimes compete with them. To wit: Forty-six percent of bank loans outstanding to NDFIs are with mortgage (23%) and private credit (23%) intermediaries. To get a better understanding of this growing sector, ProSight contacted Jill Cetina, Executive Professor and Associate Director of the Commercial Banking Program at Texas A&M’s Mays Business School. In an interview, Cetina—who is also a former vice president of supervision for the Federal Reserve Bank of Dallas and associate managing director for US banks at Moody’s —provided her views on the growth of NDFI lending, the risks it presents to banks, and how risks can be mitigated. The details are below:
The Rise of NDFIs
For a decade, bank lending to NDFIs has been rising at an annual clip of 26%, according to the St. Louis Fed. How did we get here? Cetina said the 2013 inter-agency leverage lending guidance was a key factor. While the guidance limited bank lending to leveraged corporate borrowers, she noted, it did not prevent banks from lending to NDFIs that then loaned funds on “to the same higher-risk obligors.” Meanwhile, she said, certain institutional investors were seeking “higher yielding assets than they could find in the corporate bond market”—including defined benefit pension plans that were faced with higher capital needs related to rising life expectancy. NDFIs “found markets for the leveraged corporate credit assets that they originated with insurers and pensions, and found funding and partnerships with banks,” Cetina said.
Financial conditions in recent years have also accelerated NDFI growth, including “an inverted to flat yield curve, ample Fed liquidity, and low credit losses,” Cetina said. “Corporate-focused NDFIs originate floating rate assets, obtain credit ratings, and issue debt in public markets to help fund themselves. When interest rates rose after COVID, the value of their assets increased and boosted their credit ratings.” Meanwhile, an inverted or fairly flat yield curve provided another tailwind. At the same time that rates on these floating loans NDFIs issued were rising, NDFIs could borrow to fund themselves longer term but with low term premia. “Ample liquidity in banks courtesy of the Fed also helped NDFIs on contingent funding,” Cetina said. But now “the calculus on corporate NDFI asset-liability management is worsening with short-term interest rates coming down, the Fed tightening banking sector liquidity, and the yield curve trying to steepen.” Cetina said the “ALM-driven phase of private credit growth due to favorable financial conditions now looks to be over.”
Mitigating the Risks of NDFI Lending
Lending to NDFIs can and has been a fruitful relationship for banks industrywide. But because they are not regulated the way banks are, NDFI lending standards can vary widely. “It is crucial that banks deeply understand NDFIs’ underwriting, credit monitoring, and workout processes,” Cetina said. “Irrespective of the 20% risk weight that regulators have assigned to NDFI exposures under the risk-based capital standard, if the economics of these exposures truly are more akin to leveraged lending, then bank management teams and boards need to recognize the economics and ensure that the bank has enough capital behind these credits,” she said. “There is no free lunch.”
Cetina said other concerns she has about NDFI lending include the effect tariffs and economic policies are having on NDFIs’ exposures and how the assets they hold are currently being valued. “Asset values in private markets are described as high and stable,” she said, but the stock prices of publicly traded business development corporations have fallen back to Liberation Day levels—suggesting “the potential for NDFI credit downgrades in the future.”
Cetina said banks should get a full understanding of the risk related not only to on-balance sheet lending to NDFIs—the money that has actually been transferred to the firms—but also their off-balance sheet exposure: the money that could be drawn down on the credit lines banks have made available to NDFIs. The International Monetary Fund recently put the amount of undrawn bank credit to NDFIs at over $900 billion.
Banks seeking to pull back on existing NDFI relationships can “review their loan documentation to determine the strength of material adverse change and other covenants,” Cetina said. Banks that roll forward with lines in place should expect higher drawdowns from the sector “when NDFI asset origination begins to back up on their balance sheets and the NDFI asset distribution channel becomes clogged.” A recent “drive to place private credit assets with high-net-worth retail investors arguably could be a signal that the NDFI distribution channel is becoming a concern.” For that reason, she said, banks may want to explore how NDFI loan commitments, if drawn, can affect banks’ liquidity, contingent funding plans, and capitalization ratios.
Meanwhile, allegations of fraud affecting a handful of NDFIs are an opportunity to double down on due diligence around collateral—including ensuring that loan agreements guard against subordination of a bank’s collateral rights to an NDFI lender when a loan goes bad. Cetina said NDFIs “seem to have tried to take a lot of collateral in their credit extensions. While their due diligence on the collateral has demonstrated some notable weaknesses, broadly it suggests that NDFIs seek to subordinate an obligor’s other creditors, including banks and bondholders.”
By Frank Devlin
