BIS Paper on Impact of Non-Bank Intermediation on Financial Stability
The Bank of International Settlements (BIS) published a paper that discusses the financial stability implications of the developments in the non-bank financial intermediation sector. The paper lays out a framework for the key channels of systemic risk propagation in the presence of non-bank financial intermediaries, emphasizing the central role of leverage fluctuations through changes in margins. In the framework, deleveraging and "dash for cash" scenarios (as during COVID-19) emerge as two sides of the same coin, rather than being two distinct channels of stress propagation. These findings have implications for the design of non-bank financial intermediary regulations and of central bank backstops.
The paper begins by offering a high-level overview of the increasing footprint of non-bank financial intermediaries in the financial system and looks at selected factors behind their growth. Next, it 2 highlights that systemic risk in non-bank financial intermediary activities often stems from their liability structure—chiefly the use of leverage together with their role in liquidity/maturity transformation. It also describes the mapping between non-bank financial intermediary activities and sources of systemic risk, focusing in particular on those intermediaries that can give rise to substantial liquidity demand during times of market turmoil. Then, it lays out the conceptual framework that formalizes the key channels of systemic risk propagation in market-based intermediation involving non-bank financial intermediaries and uses examples from March 2020 to showcase the key elements of the framework empirically, before finally summarizing key policy and implications and conclusions.
The paper notes that the greater footprint of non-bank financial intermediaries raises the importance of regulations. A key implication of taking a broad-based perspective is that containing solvency risk and addressing investor protection is not sufficient by itself to contain systemic risk. A pure solvency-based perspective is of limited use, since it ignores the externalities and feedback effects that underpin system risk. This calls for a macro-prudential approach toward non-bank financial intermediation regulation. In the new market intermediation ecosystem, margin requirements take on a pivotal role for the propagation of financial conditions through fluctuations in leverage. The paper also finds that the prominent role of the non-bank financial intermediaries has brought benefits by diversifying funding sources, but it has also exacerbated some liquidity imbalances that can, in extreme cases, endanger financial stability. The framework presented in this paper implies that sharp increases in margins, especially after a protracted period of thin margins, will tighten financial conditions for the system as a whole. It also points to a tight link between deleveraging and "dash for cash," as during the COVID-19 pandemic. The systemic relevance of non-bank financial intermediaries raises questions about the appropriate policy strategies. In particular, there is an important correspondence between access to public resources and oversight.
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Keywords: International, Banking, NBFI, Liquidity Risk, Systemic Risk, Financial Stability, BIS
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