Shadow Always Touches the Feet: Implications of Bank Credit Lines to Non-Bank Financial Intermediaries

Using real estate investment trusts (REITs) that invest in commercial real estate (CRE) as a leading example, we study the implications for banks of extending credit lines to “shadow banks” or non-bank financial intermediaries (NBFIs). While small and mid-size banks hold an economically significant direct exposure in CRE term loans, a significant part of the CRE exposure of large banks is indirect via credit-line provision to REITs. Utilization of credit lines by REITs tends to be substantially more sensitive to market stress than non-financial corporates and other NBFIs. In turn, large banks suffer drawdowns and equity corrections in stress times from extending credit lines to REITs. Ignoring this NBFI credit line channel understates the exposure of large banks to stress. We propose a methodology to incorporate this exposure and its heterogeneity in bank capital stress tests.