Question

In our lecture about the 2008 Financial Crisis, we discussed the “Financial Crisis Death Spiral” highlighting the major disadvantages of the non-bank finance channel. Discuss these disadvantages.

Answer 1

In the last few years these alternative forms of financing have come up as a both, an opportunity and challenge for the borrower and regulator. The major disadvantage associated with these forms of lending are they are not completely regulated. Lack of regulation can be a serious issue in these type of financing as regulators are still finding it difficult as to how to regulate these alternative forms of lending and other currencies like cryptos. The major issue with unregulated market is it can create unnecessary bubbles which when bust can cause serious damage to the entire financial system which is evident from historical financial crisis. Another major issue is the risk f high default in these types of lending, the alternative sources of finance do not charge low interest rate, normally it is slightly higher than the traditional bank so there is high probability of default also. The term of the loan is another issue from the borrower perspective as it is often a short-term borrowing.