Rise of Debt and Market Based Finance

Rise of Debt and Market Based Finance

It is also known as Non Bank finance or Shadow Banking.

The key difference between traditional banking and shadow banking is fragmented credit chains in the shadow banking.

Traditional Banking does

  • Maturity Transformation
  • Liquidity Transformation
  • Credit Transformation

While traditional banking has backstops

  • Deposit Insurance
  • Central bank

Shadow Banks are not regulated and do not have advantage of backstops.

Hence they are susceptible to systemic risk and runs.

Questions

  • What is Market based Finance?
  • How big is the market?
  • Institutions?
  • Instruments?
  • Who are the borrowers?
  • Who are the investors?
  • What are the risks in market based finance?
  • Role of Central Banks?
  • How to minimize risks?
  • Regulations? Macro Prudential policies?
  • How are banks involved in market based finance?
  • How are they connected to each other and others?

Key Terms

  • Market based Finance MBF
  • Non Bank Credit Intermediation NCBI
  • Shadow Banking
  • Financial Stability
  • Systemic Risk
  • Liquidity Risk
  • Broker Dealers
  • Non Bank Finance NBF
  • Balance Sheet Economics
  • Market Makers
  • Capital Markets
  • Money Markets
  • Money View
  • Money Flows
  • Network Dynamics
  • Regulatory Arbitrage
  • Credit Chains
  • Fragmented Credit Chains
  • Financial Supply Chains
  • Credit Chain Length
  • Growth of Debt

Growth and Size of Market based Finance

Image Source: BANK AND NONBANK LENDING OVER THE PAST 70 YEARS

Image Source: Shining a Light on Shadow Banking

Image Source: The Shadow Banking System in the United States: Recent Developments and Economic Role

Image Source: Shining a Light on Shadow Banking

Image Source: NON-BANK FINANCE: TRENDS AND CHALLENGES

Image Source: THE GROWTH OF NON-BANK FINANCE AND NEW MONETARY POLICY TOOLS 

Image Source: SHADOW BANKING AND MARKET BASED FINANCE

Structural Dynamics of Banking and Financial System

Changes prior to Global Financial Crisis

  • Rise of Debt
  • Rise of Market Based Finance
  • Increase in capital flows both domestic and cross border

Debt dynamics is related to assets side of balance sheet of financial intemediatory.

Market based Finance is related to liabilities side of balance sheet of Financial Intermediatory.

If the chains of financial intermediation are long, then both assets and liabilities of each participant are linked.

Intermediation results in increase of capital flows. From money markets to capital markets. From deposits to loans. From liabilities to assets. There is both pull and push of money flows in the financial system. Demand for capital and supply of capital. They both are linked by banks and non bank finance. Growth of debt is linked to growth of money markets and non bank finance.

Size of Nonfinancial Business and Household Credit

Image Source: FINANCIAL STABILITY REPORT – NOVEMBER 2020

In a future post I will discuss debt in US and global financial system.

Please see my related posts for evolution of Financial System Complexity and Its dynamics.

Low Interest Rates and Banks’ Profitability – Update October 2020

Funding Sources and Liquidity for US Commercial Banks

Trends in Assets and Liabilities of Commercial Banks in the USA

Size and complexity arise together. Along with balance sheet expansion comes changes in links with counterparties (financial networks and interconnections).

Research continues in this area by several institutions and academics.

  • OECD
  • BIS
  • FED RESERVE
  • ECB
  • FSB
  • BOE
  • IMF
  • BOF
  • Others

Source: Structural developments in global financial intermediationThe rise of debt and non-bank credit intermediation

The global financial crisis of 2008 underlined the importance for policy makers in understanding the scale and types of financial intermediation in their economies. During the financial crisis, non-bank financial intermediation was of particular concern to authorities, as such forms of ‘shadow banking’, contributed to both the root causes of the crisis, the transmission of financial contagion, and the amplification of shocks.

As this report is published, the rapid spread of the novel coronavirus Covid-19 has caused a global health crisis, has brought economic activity in some sectors to a halt, and has presented the greatest challenge to the global financial system since 2008. As then, understanding financial intermediation activities is critical to mapping the faultlines in the global financial system and mounting effective policy responses.

However, the shape of financial intermediation has changed in important ways since the global financial crisis. Activities in non-bank intermediation, including market-based intermediaries like investment funds and securitised products, have grown and are increasingly interconnected with financial markets. Understanding the interplay between these elements, and the benefits and risks of each, offers a more complete understanding of how global finance can contribute to sustainable economic growth. It also helps provide the full picture needed to help policy makers prepare for and respond to shocks, including pandemics.

“Structural developments in global financial intermediation: The rise of debt and non-bank credit intermediation” shines a light on the evolution of global financial intermediation in three key ways. First, it maps the broad-based growth of financial intermediation relative to GDP in many advanced and emerging market economies, and with this growth a shift toward market-based finance. Second, it assesses the shift from equity to debt markets, and the growing imbalances in sovereign and corporate debt markets during a period of highly accommodative monetary policies. Third, it draws attention to key activities in credit intermediation that could contribute to structural vulnerabilities in the global financial system, including: a sharp rise of below-investment grade corporate debt, in particular leverage loans and collateralised loan obligations; the growth of open-ended investment funds that purchase high-yield debt and leveraged loans; and risks associated with the large stock of bank contingent convertible debt.

While these various activities have helped to satisfy investors’ reach for yield during years of market exuberance, they represent new potential faultlines of systemic risk in the event of exogenous shocks, be they from trade tensions, geopolitical risks or the current global pandemic. This report underlines the need for policy frameworks to adapt to market-based finance, and fully reflect the interaction between monetary, prudential, and regulatory tools on credit intermediation. It also underlines the need for dynamic microprudential and activities-based tools to help mitigate excessive risk taking with respect to liquidity and leverage.

By mapping the global financial system, evaluating growing imbalances and risks that could amplify shocks, and assessing the interaction between macro and regulatory tools, this report provides a practical complement to the OECD’s Policy Framework for Effective and Efficient Financial Regulations. Financial authorities should use this analysis to inform both their assessments of activities and risks, and efforts to maximise available tools to harness the benefits of market-based finance to support fair, efficient markets and sustainable economic growth.

Greg Medcraft Director, OECD Directorate for Financial and Enterprise Affairs

Image Source: UNDERSTANDING THE RISKS INHERENT IN SHADOW BANKING: A PRIMER AND PRACTICAL LESSONS LEARNED

Image Source: THE ECONOMICS OF SHADOW BANKING 

Image Source: IS SHADOW BANKING REALLY BANKING?

Table Source: SHADOW BANKING AND MARKET BASED FINANCE

Table 1. A Stylized View of Structural Characteristics of Credit-based Intermediation

Characteristic:Traditional BankingShadow BankingMarket-based Finance
Key Risk TransformationsLiquidity, maturity, leverageCredit enhancement,liquidity, maturity, leverageLess emphasis on credit enhancement and less opaque vs. shadow banking
Institutions Involved in Intermediation Single entityCan be many entities, interconnected through collateral chains and credit guaranteesSingle/few entities
Formal Ex-anteBackstopYesNo / IndirectNo
Implied Sponsor Supportn.a.Yes, can sometimes be contingent liabilitiesNo(insolvency remote)
Example of EntitiesCommercial bankSynthetic CDO, Structured Investment Vehicle (SIV), CNAV MMF, ABCP ConduitBond mutual fund, Distressed debt or PE partnership,Direct lending by pension fund
Main Form of LiabilitiesDebt and deposits,Wholesale & retail-financedDebt,Mainly wholesale financedHighly diverse –Short and long-term debt and equity,Retail & wholesale financed
Key Resulting Financial Stability Risk Systemic risk(institutional spillovers)Systemic risk(institutional spillovers)Shift in price of risk (market risk premia)

My Related Posts

Shadow Banking

Economics of Broker-Dealer Banks

Evolution of Banks Complexity

Low Interest Rates and International Capital Flows

Repo Chains and Financial Instability

Global Liquidity and Cross Border Capital Flows

The Dollar Shortage, Again! in International Wholesale Money Markets

Low Interest Rates and Banks’ Profitability – Update October 2020

Funding Sources and Liquidity for US Commercial Banks

Funding Strategies of Banks

Trends in Assets and Liabilities of Commercial Banks in the USA

Key sources of Research

The growth of non-bank finance and new monetary policy tools 

Adrien d’Avernas, Quentin Vandeweyer, Matthieu Darracq Pariès  

20 April 2020

https://voxeu.org/article/growth-non-bank-finance-and-new-monetary-policy-tools

Financial Stability Report

November 2019

Board of Governors of the Federal Reserve System

Financial Intermediaries, Financial Stability, and Monetary Policy

Tobias Adrian and Hyun Song Shin
Federal Reserve Bank of New York Staff Reports, no. 346 September 2008

US BROKER-DEALER LIQUIDITY IN THE TIME OF FINANCIAL CRISIS

https://www.shearman.com/perspectives/2020/05/us-broker-dealer-liquidity-in-the-time-of-financial-crisis

Unconventional monetary policy and funding liquidity risk

ECB

Structural developments in global financial intermediation

The rise of debt and non-bank credit intermediation

by

Robert Patalano and Caroline Roulet*

OECD

https://www.oecd-ilibrary.org/finance-and-investment/structural-developments-in-global-financial-intermediation-the-rise-of-debt-and-non-bank-credit-intermediation_daa87f13-en

Financial Stability Review, May 2020

ECB

https://www.ecb.europa.eu/pub/financial-stability/fsr/html/ecb.fsr202005~1b75555f66.en.html#toc1

Structural changes in banking after the crisis

Report prepared by a Working Group established by the Committee on the Global Financial System

The Group was chaired by Claudia Buch (Deutsche Bundesbank) and B Gerard Dages (Federal Reserve Bank of New York)

January 2018

BIS

BANK-BASED OR MARKET-BASED FINANCIAL SYSTEMS: WHICH IS BETTER?

Ross Levine

Working Paper 9138 http://www.nber.org/papers/w9138

NATIONAL BUREAU OF ECONOMIC RESEARCH

1050 Massachusetts Avenue
Cambridge, MA 02138
September 2002

Non-bank finance: trends and challenges

Financial Stability Review

Bank of France

2018

The Origins of Bank-Based and Market-Based Financial Systems: Germany, Japan, and the United States

Sigurt Vitols*

January 2001

Financial Stability Report

August 2020

Bank of England

Market-Based Finance:
Its Contributions and Emerging Issues

May 2016

Financial Conduct Authority

Bank-Based Versus Market-Based Financing: Implications for Systemic Risk

https://www.researchgate.net/publication/322088863_Bank-Based_Versus_Market-Based_Financing_Implications_for_Systemic_Risk

Off the radar: The rise of shadow banking in Europe 

Martin Hodula  

16 March 2020

https://voxeu.org/article/radar-rise-shadow-banking-europe

Global Monitoring Report on Non-Bank Financial Intermediation 2019

2020

FSB

https://www.fsb.org/2020/01/global-monitoring-report-on-non-bank-financial-intermediation-2019/

Global Monitoring Report on Non-Bank Financial Intermediation 2018

FSB 2019

https://www.fsb.org/2019/02/global-monitoring-report-on-non-bank-financial-intermediation-2018/

Global Shadow Banking Monitoring Report 2017

FSB 2018

https://www.fsb.org/2018/03/global-shadow-banking-monitoring-report-2017/

Global Shadow Banking Monitoring Report 2016

10 May 2017

FSB 2015 Report

FSB 2014 Report

https://www.fsb.org/wp-content/uploads/r_141030.pdf?page_moved=1

FSB 2013 Report

FSB 2012 Report

FSB 2011 Report

Shadow Banking: Monitoring Vulnerabilities and Strengthening Policy Tools

https://www.garp.org/#!/risk-intelligence/all/all/a1Z1W0000054xEzUAI

BANK-BASED AND MARKET-BASED FINANCIAL SYSTEMS: CROSS-COUNTRY COMPARISONS

Asli Demirguc-Kunt and Ross Levine*

June 1999

https://pdfs.semanticscholar.org/18e5/660bef2325f326bb8077bd0dd6f5225b1bf8.pdf?_ga=2.215410079.942675951.1605328042-1052966156.1604782392

Off the Radar: Exploring the Rise of Shadow Banking in the EU

Martin Hodula

https://www.cnb.cz/en/economic-research/research-publications/cnb-working-paper-series/Off-the-Radar-Exploring-the-Rise-of-Shadow-Banking-in-the-EU/

https://voxeu.org/article/radar-rise-shadow-banking-europe

Shadow Banking: Economics and Policy

Stijn Claessens, Zoltan Pozsar, Lev Ratnovski, and Manmohan Singh

IMF

2012

https://www.imf.org/en/Publications/Staff-Discussion-Notes/Issues/2016/12/31/Shadow-Banking-Economics-and-Policy-40132

Bank-Based and Market-Based Financial Systems: Cross-Country Comparisons

A. Demirguc-Kunt

Published 1999

https://www.semanticscholar.org/paper/Bank-Based-and-Market-Based-Financial-Systems%3A-Demirguc-Kunt/cd8cf558db2f8404271050ba40408a28ac4fcbc4

Market-based finance: a macroprudential view

Speech given by
Sir Jon Cunliffe, Deputy Governor Financial Stability, Member of the Monetary Policy Committee, Member of the Financial Policy Committee and Member of the Prudential Regulation Committee

BOE/BIS

Asset Management Derivatives Forum, Dana Point, California Friday 9 February 2017

Shadow Banking and Market Based Finance

Tobias Adrian, International Monetary Fund 
Helsinki

September 14, 2017

https://www.imf.org/en/News/Articles/2017/09/13/sp091417-shadow-banking-and-market-based-finance

Transforming Shadow Banking into Resilient Market-based Finance

An Overview of Progress

12 November 2015

FSB

Mapping Market-Based Finance in Ireland

Simone Cima, Neill Killeen and Vasileios Madouros1,2 

Central Bank of Ireland
December 13, 2019

BANK AND NONBANK LENDING OVER THE PAST 70 YEARS

FDIC

Financial Stability Review

November 2019

ECB

Shadow Banking

Zoltan Pozsar, Tobias Adrian, Adam Ashcraft, and Hayley Boesky

FRBNY Economic Policy Review / December 2013

https://www.newyorkfed.org/research/epr/2013/0713adri.html

Shadow Banking and Market-Based Finance

Tobias Adrian and Bradley Jones

IMF

No 18/14

Why Shadow Banking Is Bigger Than Ever

DANIELA GABOR

https://jacobinmag.com/2018/11/why-shadow-banking-is-bigger-than-ever

The Non-Bank Credit Cycle

Esti Kemp, Ren ́e van Stralen, Alexandros P. Vardoulakis, and Peter Wierts

2018-076

Fed Reserve

The role of financial markets for economic growth

Speech delivered by Dr. Willem F. Duisenberg, President of the European Central Bank, at the Economics Conference “The Single Financial Market: Two Years into EMU” organised by the Oesterreichische Nationalbank in Vienna on 31 May 2001

https://www.ecb.europa.eu/press/key/date/2001/html/sp010531.en.html

Bank deleveraging, the move from bank to market-based financing, and SME financing

Gert Wehinger

OECD

OECD Journal: Financial Market Trends Volume 2012/1
© OECD 2012

Shadow Banking: A Review of the Literature

Tobias Adrian Adam B. Ashcraft

2012 FRBNY

The Global Pandemic and Run on Shadow Banks

FRBKC

2020

https://www.kansascityfed.org/en/publications/research/eb/articles/2020/global-pandemic-run-shadow-banks

Shadow Banking: The Rise, Risks, and Rewards of Non-Bank Financial Services

Roy J. Girasa

The Macroeconomics of Shadow Banking

ALAN MOREIRA and ALEXI SAVOV∗

THE JOURNAL OF FINANCE • 2017

Is Shadow Banking Really Banking?

Bryan J. Noeth ,  Rajdeep Sengupta

Saturday, October 1, 2011

FRBSL

https://www.stlouisfed.org/publications/regional-economist/october-2011/is-shadow-banking-really-banking

Three Essays on Capital Regulations and Shadow Banking

Diny Ghuzini
Western Michigan University, diny.ghuzini@wmich.edu

CLARIFYING THE SHADOW BANKING DEBATE: APPLICATION AND POLICY IMPLICATIONS

Amias Gerety 2017

Institute of International Economic Law Georgetown University Law Center

Commercial Banking and Shadow Banking

The Accelerating Integration of Banks and Markets and its Implications for Regulation

ARNOUD W. A. BOOT AND ANJAN V. THAKOR

(prepared as revised version of Chapter 3 in The Oxford University Press Handbook, The Accelerating Integration of Banks and Markets and its Implications for Regulation, 3rd edition.)

The Shadow Banking System in the United States: Recent Developments and Economic Role

Tresor Economics

France

2013

https://www.tresor.economie.gouv.fr/Articles/ccfd4180-fddb-4333-bd16-0b91f2daa18c/files/6ae6455a-92be-43a5-a94d-91b03b38a8d8

Shadow Banking: Policy Challenges for Central Banks

Thorvald Grung Moe*

Levy Economics Institute of Bard College

May 2014

BANKS, SHADOW BANKING, AND FRAGILITY

Stephan Luck and Paul Schempp

2014 ECB

Restructuring the Banking System to Improve Safety and Soundness

Thomas M. Hoenig
Vice Chairman of the Federal Deposit Insurance Corporation

Charles S. Morris
Vice President and Economist Federal Reserve Bank of Kansas City

Original version: May 2011 Revised: December 2012

Understanding the Risks Inherent in Shadow Banking: A Primer and Practical Lessons Learned

by David Luttrell Harvey Rosenblum and Jackson Thies

FRB Dallas

Shadow Banking Concerns: The Case of Money Market Funds

Saad Alnahedh† , Sanjai Bhagat

Towards a theory of shadow money

Daniela Gabor* and Jakob Vestergaard

The Economics of Shadow Banking 

Manmohan Singh

2013

Regulating the Shadow Banking System

GARY GORTON

ANDREW METRICK

Yale University

The Rise of Shadow Banking: Evidence from Capital Regulation

Rustom M. Irani, Raymakal Iyer, Ralf R. Meisenzahl, and Jos ́e-Luis Peydr ́o

2018-039

Fed Reserve

Shadow Banking: Background and Policy Issues

Edward V. Murphy

Specialist in Financial Economics

December 31, 2013

Shining a Light on Shadow Banking

The Clearing House

https://www.theclearinghouse.org/banking-perspectives/2015/2015-q4-banking-perspectives/articles/shining-a-light-on-shadow-banking

REGULATING SHADOW BANKING*

STEVEN L. SCHWARCZ

2011

Duke Law

Money Creation and the Shadow Banking System Adi Sunderam

Harvard Business School and NBER September 2014

https://dash.harvard.edu/bitstream/handle/1/27336543/sunderam_money-creation.pdf?sequence=1

Financial Crisis Inquiry Commission Report Chapter 2

Shadow Banking

THE SHADOW BANKING CHARADE

By Melanie L. Fein*

February 15, 2013

Assessing shadow banking – non-bank financial intermediation in Europe

No 10/ July 2016

by
Laurent Grillet-Aubert Jean-Baptiste Haquin Clive Jackson
Neill Killeen
Christian Weistroffer

ESRB

Shedding Light on Shadow Banking

Timothy Lane

Bank of Canada

shadow banking and capital markets

RISKS AND OPPORTUNITIES

Group of Thirty

Shadow Banking and Market Based Finance

Tobias Adrian, International Monetary Fund 
Helsinki

September 14, 2017

https://www.imf.org/en/News/Articles/2017/09/13/sp091417-shadow-banking-and-market-based-finance

Financial Stability Report – November 2020

Federal Reserve

https://www.federalreserve.gov/publications/2020-november-financial-stability-report-purpose.htm

https://www.federalreserve.gov/publications/2019-november-financial-stability-report-purpose.htm

https://www.federalreserve.gov/publications/2018-november-financial-stability-report-purpose.htm

https://www.federalreserve.gov/publications/financial-stability-report.htm

Author: Mayank Chaturvedi

You can contact me using this email mchatur at the rate of AOL.COM. My professional profile is on Linkedin.com.

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