Disintermediation of Banking

For most of the twentieth century, if a corporation needed to fund operations or expansion, it borrowed from a bank. The bank assessed credit risk, held the loan to maturity, and bore the loss if the borrower defaulted. This relationship slowly dissolved. By the 1990s, large corporations could issue bonds directly to capital markets, syndicate loans to dozens of lenders instantly, or raise equity without a bank intermediary. The bank’s role shifted from lender to arranger and trader—and smaller firms were left behind.

The banking intermediation model

In the postwar decades, the bank was the primary financial intermediary for companies. A firm with a need for capital approached a bank. The bank assessed the company’s balance sheet, cash flow, management quality, and industry. If satisfied, it extended a loan—typically a relationship loan, held on its books, with periodic review and covenant monitoring. The bank charged an interest rate above its cost of debt to cover credit losses and operating expenses. The difference was the bank’s profit margin.

This model had structural advantages. The bank had a strong incentive to monitor the borrower (it bore the loss if the loan went bad). It had flexibility to renegotiate terms if circumstances changed. It could offer long-term stability even if the firm had a temporary downturn. The bank’s relationship manager understood the borrower’s business.

It also had costs. The bank faced liquidity risk if it funded long-term loans with short-term deposits. It faced credit risk that its fee did not always fully cover. It had to hold capital against potential losses. And the borrower was often locked into a single bank or a small syndicate, with limited ability to shop for better rates once the loan was originated.

The emergence of capital markets alternatives

Starting in the 1960s, large, creditworthy corporations began issuing bonds directly to investors rather than relying on bank loans. The corporate bond market grew. A company with an investment-grade credit rating could access capital far more cheaply by issuing a bond than by borrowing from a bank. Investors—insurance companies, pension funds, bond traders—became willing to hold these bonds, especially as information disclosure improved.

The commercial paper market also emerged. A company could issue short-term notes (maturing in days or weeks) directly to money market investors, rolling them over as needed. This was cheaper than a bank credit line and more flexible.

As capital markets deepened and securitisation technology improved, the range of what could be funded in markets expanded. By the 1980s, corporate debt issuance in capital markets was outpacing bank lending for large firms. By the 1990s, even mid-sized companies could raise capital by issuing bonds or commercial paper.

The bank’s role transformed

This did not mean banks disappeared from corporate finance. Instead, their role shifted from lender to intermediary and arranger. Under the new model:

A bank would arrange a bond offering, taking it public to investors and collecting a fee. Or it would syndicate a loan to dozens of institutional lenders (pension funds, insurance companies, other banks), each holding a piece, collecting a fee for arranging. The bank itself might hold only a small slice of the risk, if any. Or a bank would provide a credit line—a commitment to lend if needed—for a fee, allowing the company to access capital markets when conditions were good and tap the line in a stress.

Investment banks, in particular, benefited. The ability to raise capital through markets rather than bank loans meant corporations needed arrangers, bookrunners, and advisers who understood markets. Goldman Sachs, Morgan Stanley, and other investment banks became more powerful and more profitable than traditional commercial banks.

Commercial banks, by contrast, faced shrinking lending margins. As their largest, most creditworthy customers moved to capital markets, banks were left lending to smaller companies, startups, or marginal borrowers. The credit spread on these loans had to compensate for higher loss rates. Banks adapted by originating loans to sell to investors (the mortgage-backed securities boom), expanding into asset management, and pursuing higher-risk lending to emerging markets.

Consequences for stability and access

The shift from bank lending to capital markets had profound implications.

For large firms: Access to capital markets meant cheaper funding, greater flexibility, and less dependence on any single bank. Large corporations could now raise capital from thousands of small and large investors worldwide. A company with a temporary credit downgrade could still find investors willing to buy its bonds at a higher yield, rather than being forced to pay whatever terms its bank demanded. This competition for corporate borrowers was genuinely beneficial.

For financial stability: The diffusion of credit risk across many investors (rather than concentrated on banks’ balance sheets) reduced the risk of bank failures triggered by a single bad loan or sector downturn. But it also meant that systemic risk became harder to monitor and manage. A bank at risk of failure could be identified quickly; a fragmented risk of losses across thousands of bond investors and shadow banks was invisible until crisis struck.

For smaller firms: They never gained access to capital markets on reasonable terms. A startup or mid-market firm still needed bank credit. But as banks retreated from the middle market, lending standards tightened and rates rose. Smaller firms increasingly relied on bank relationships, venture capital, or internal cash flow. The exit of banks from certain market segments actually tightened credit for these borrowers.

For credit discipline: Under the old model, a bank lender could quietly tolerate a borrower’s temporary distress by renegotiating terms or extending maturity—if it believed in the underlying business. Bond investors, dispersed and trading actively, had less ability to renegotiate. A company in distress might face a sudden collapse of investor demand, forcing it into restructuring or bankruptcy even if the core business was viable. This created more dramatic boom-bust cycles for some issuers.

Disintermediation accelerated by other trends

The shift was also enabled by technology and regulation. Improvements in financial information disclosure, accounting standards (GAAP, later IFRS), and rating agencies (credit rating agencies) reduced the informational advantage banks had over arm’s-length bond investors. Electronic markets allowed pricing to become more transparent and efficient. Regulatory changes (like changes to reserve requirements) sometimes made capital market funding cheaper relative to bank borrowing.

The Big Bang and other deregulations of the 1980s accelerated the process by allowing investment banks to trade actively and by dismantling some regulatory barriers between different types of intermediaries. The rise of institutional investors as dominant equity and bond buyers also mattered; they preferred to deploy capital directly in securities rather than through bank intermediaries.

The recent arc and the 2008 crisis

By 2007, bank lending as a share of corporate financing in developed economies had fallen to around 30–40%, with capital markets handling 60–70%. The system appeared to have evolved successfully from bank-centred to market-centred finance.

Then came the 2008 financial crisis. The mortgage-backed security market—where banks had securitised home loans and sold them to investors—collapsed when housing prices fell. Confidence in complex securities evaporated. Companies that had relied on rolling over commercial paper suddenly couldn’t—money market funds refused to buy. The credit markets froze.

Ironically, corporations then discovered they still needed banks. Companies drew on credit lines they had with banks to survive the crisis. Banks that survived became more critical, not less. Governments recognised that the diffusion of risk across financial markets, while removing bank-specific fragility, had created systemic risk that could threaten the entire system if not carefully managed.

Post-2008 regulation attempted to rebuild some role for relationship banking (through dodd-frank-act and Basel III reforms), but the fundamental shift from bank intermediation to capital markets finance was irreversible. The tension between these two modes of finance—concentrated credit risk in banks versus diffused, opaque risk in markets—remains unresolved.

See also