EU non-bank finance returns to growth

Key Question Being Explored in This Insight:

Non-bank financial intermediation is increasingly crucial for EU credit and financial markets, with 2023 marking renewed growth, but it also presents stability risks, especially through leverage, liquidity mismatches, and interconnectedness; Richard Portes reviews these structural risks, explores developments in private finance and crypto, and emphasizes the need for a holistic view in EU regulatory discussions on non-bank finance.

View the page of: Richard Portes

Institution: London Business School

Explore more insights in:

Economic Policy Economics Financial Economics Social Sciences

Media Literacy Toolkit

Faculti's Media Literacy Toolkit helps viewers critically engage with academic insights by analyzing the research context, identifying perspectives, and encouraging thoughtful evaluation.

Critical Questions to Consider ▼

What assumptions does the research make?
Are there alternative perspectives not explored?
What are the limitations of the research method?

Bias and Perspective Awareness ▼

This research comes from London Business School . Reflect on how the institution's academic focus and research partnerships may shape the questions being explored.

Further Reading ▼

Read the Study

Image courtesy of interviewee. October 31, 2024

Log-in or Sign-up to Faculti
Currently viewing this subject insight as a guest. You have insight(s) remaining for this month. Login to view 8000+ figures on the platform.

Generating Workspace...

Export as PDF

This video discusses the roles and risks associated with banks and non-bank financial intermediaries in the financial system. Banks hold deposit liabilities, make loans, and must adhere to regulatory minimum equity capital. In contrast, many non-bank financial intermediaries, like asset managers, don't have significant balance sheets and are primarily channels for investor funds into various assets. The risks for these assets fall on the investors, not the intermediaries, which often face little regulation and no central bank support during crises.

Key examples of failures, such as the 2008 crisis involving AIG and the recent collapse of the family office Argos, highlight the potential systemic risks these intermediaries pose, particularly through interconnectedness with banks. This video emphasizes that although non-bank entities can diversify risks and channel savings into investments, they can increase systemic debt and liquidity risks.

Specific concerns include the increasing relevance of crypto assets, with both banks and non-bank intermediaries exposed to the volatile crypto market. Moreover, the limited regulation around money market funds and private credit, which has grown significantly, raises alarms among financial authorities. The evolving relationships between banks and non-bank financial actors necessitate better monitoring and regulation to prevent potential adverse effects on financial stability. This video concludes that non-bank financial intermediation has become a critical area of concern for policymakers globally.

Language:

Export as PDF

Export as PDF
Here are five key points summarizing the video regarding the risks and regulatory challenges associated with non-bank financial intermediaries:

1. **Regulatory Gaps and Risks**: Non-bank financial intermediaries (NBFIs), unlike banks, generally face little to no regulation, exposing the financial system to significant risks, such as liquidity risks, leverage, and poor oversight of interconnectedness with the banking sector. The lack of backstop mechanisms (like central bank support) increases the potential for failure and broader financial instability.

2. **Impact of the 2008 Financial Crisis**: The video refers to the impact of the 2008 financial crisis—specifically the failure of major companies like AIG and the knock-on effects that contributed to the downfall of banking institutions like Credit Suisse. These events underline the interconnectedness between banks and NBFIs, highlighting how risks can propagate across the financial system.

3. **Liquidity Risks from Investment Products**: Specific examples of liquidity risks are , such as open-ended real estate funds and money market funds, which can face runs when investors seek to withdraw their funds. These scenarios may force funds to impose restrictions (gates) or liquidate assets, thereby affecting market stability.

4. **Interconnectedness of Crypto and Banking Sectors**: The growth of the crypto sector and the issuance of crypto products by asset managers raise concerns about their impact on traditional banks. Events like the failure of Silicon Valley Bank are tied to significant exposure to crypto, demonstrating the risks present when traditional finance intersects with high-risk assets.

5. **Growing Role of Private Credit and Lack of Oversight**: The expansion of private credit, which is increasingly used by non-bank lenders to provide loans to riskier firms, has raised alarms regarding inadequate due diligence compared to traditional banking practices. This shift, along with the growth of the asset management sector independent of banks, poses risks to financial stability, especially in the convideo of insufficient regulatory frameworks to address these evolving dynamics.

Export as PDF
Here are key quotes extracted from the video that highlight the main themes and points discussed:

1. **On the nature of financial intermediaries:**
- "Banks have deposit liabilities and assets in the form of loans and an equity capital base that's quite subject to regulatory minimum."
- "Most non-bank financial intermediaries... don't have significant balance sheets."

2. **On risks and regulation:**
- "The risks associated with those assets are born by the non-bank financial intermediaries."
- "The non-bank financial intermediaries are subject to little or no regulation, and they have no backstops... and they can fail."
- "They can pose liquidity risks... we've seen... the liquidity risks posed by open-ended real estate funds."

3. **On historical examples of risk:**
- "A big example, of course, was AIG, the big insurer in the crisis of 2008, which was one of the biggest bailouts ever."
- "The banks didn't know... what AIG was borrowing from the others... and that contributed to the downfall of Credit Suisse in March 2023."

4. **On the role of central banks:**
- "The central banks may be forced to intervene as market makers of last resort."
- "The problem with the non-bank financial intermediaries from the point of view of the authorities is that they're not really very much regulated."

5. **On interconnectedness:**
- "We are concerned that crypto market disturbances could spread to traditional finance, in particular the banks."
- "There are rising valuations... and we had this growth of private credit... which is a rapidly growing sector."

6. **On private credit and the risk profiles:**
- "Private credit is now probably over 3 trillion in Europe... and that's a non-trivial number."
- "The borrowers ultimately can handle that burden... and poses risks to the non-bank financial intermediation system."

7. **On regulatory challenges:**
- "We maintain that that regulation is insufficient... we have proposed that the European Systemic Risk Board... a number of what we think are important."
- "There are issues that were supposedly dealt with in the European Union by a regulation in 2017... that worries us."

8. **On the growing concern of non-bank financial intermediation:**
- "The authorities are more concerned now with non-Bank financial intermediation than they used to be."
- "Non-Bank financial intermediation has... certainly top of the list for policy makers."

These quotes encapsulate the essence of the discussion on the risks posed by non-bank financial intermediaries, their lack of regulation, the historical convideo of failures, and the interconnectedness with traditional banks and financial systems.

X-TIMESTAMP-MAP=LOCAL:00:00:00.000,MPEGTS:90000

1
00:00:00.095 --> 00:00:02.685
Banks have deposit liabilities

2
00:00:02.985 --> 00:00:04.645
and assets in the form of loans

3
00:00:05.345 --> 00:00:08.365
and an equity capital base that's quite subject

4
00:00:08.545 --> 00:00:09.965
to regulatory minimum.

5
00:00:10.355 --> 00:00:14.325
Whereas most non-bank financial intermediaries, except

6
00:00:14.325 --> 00:00:16.045
for money market funds and pension funds

7
00:00:16.045 --> 00:00:19.485
and insurers don't have significant balance sheets.

8
00:00:20.215 --> 00:00:23.685
Asset managers, in particular channel investors funds

9
00:00:24.795 --> 00:00:27.685
into assets owned by those investors.

10
00:00:28.545 --> 00:00:31.525
The risks associated with those assets are born

11
00:00:31.705 --> 00:00:33.485
by the investors, not

12
00:00:33.545 --> 00:00:35.445
by the non-bank financial intermediaries.

13
00:00:36.965 --> 00:00:40.145
On the other hand, the non-bank financial intermediaries

14
00:00:40.685 --> 00:00:42.585
are subject to little or no regulation,

15
00:00:43.085 --> 00:00:46.945
and they have no backstops in the form of central banks

16
00:00:47.525 --> 00:00:49.625
as lenders of last resort as we put it.

17
00:00:50.335 --> 00:00:51.635
Uh, and they can fail.

18
00:00:52.355 --> 00:00:56.555
A big example, of course, was a IG, the big insurer in,

19
00:00:56.735 --> 00:00:59.475
the crisis of 2008, which was one

20
00:00:59.475 --> 00:01:02.275
of the biggest bailouts ever, right?

21
00:01:02.655 --> 00:01:06.635
And more recently, there was a big family office, Argos,

22
00:01:06.925 --> 00:01:10.955
which failed, and required, not a bailout.

23
00:01:11.175 --> 00:01:15.595
Nobody was gonna step into, bail them out, but it,

24
00:01:16.015 --> 00:01:20.115
and it didn't require, it implied a lot of losses

25
00:01:21.095 --> 00:01:24.635
for those banks that extended loans to it.

26
00:01:24.855 --> 00:01:26.955
The banks didn't know each of them

27
00:01:27.505 --> 00:01:29.515
what Arch Chagos was borrowing from the others.

28
00:01:29.975 --> 00:01:32.475
And so you had a knock on effect in particular

29
00:01:33.015 --> 00:01:37.595
for credit sus, which was exposed about $5 billion worth,

30
00:01:37.685 --> 00:01:39.915
maybe more to Argos.

31
00:01:40.095 --> 00:01:43.875
And that contributed to the downfall of Credit Sus,

32
00:01:43.935 --> 00:01:45.515
in March, 2023.

33
00:01:45.735 --> 00:01:47.955
The central banks may be forced to intervene

34
00:01:48.825 --> 00:01:51.845
as market makers of last resort because

35
00:01:53.205 --> 00:01:55.365
although they won't want to support

36
00:01:56.065 --> 00:01:59.605
the non-bank financial intermediaries themselves,

37
00:01:59.755 --> 00:02:01.845
they don't want markets to freeze up.

38
00:02:02.525 --> 00:02:06.585
Uh, and you could see that happen in, for example, the dash

39
00:02:06.645 --> 00:02:09.985
for cash in March of 2020 when a number

40
00:02:09.985 --> 00:02:12.985
of money market funds, for example, got into deep trouble

41
00:02:13.405 --> 00:02:17.465
and the central banks did have to step in to deal with them,

42
00:02:18.045 --> 00:02:21.145
as well as corporate bond funds, for example.

43
00:02:21.365 --> 00:02:23.945
So the problem with the non-bank financial intermediaries

44
00:02:23.945 --> 00:02:26.025
from the point of view of the authorities is

45
00:02:26.025 --> 00:02:28.105
that they're not really very much regulated.

46
00:02:28.355 --> 00:02:31.265
Money market funds are some, but, but

47
00:02:31.265 --> 00:02:34.225
otherwise there's not much, and,

48
00:02:34.365 --> 00:02:38.265
and yet they compose major dangers to the financial system.

49
00:02:38.365 --> 00:02:40.385
The benefits are that these non-bank financial

50
00:02:40.385 --> 00:02:43.305
intermediaries channel funds from savings into investment,

51
00:02:43.765 --> 00:02:45.105
and they diversify risks,

52
00:02:46.165 --> 00:02:49.465
but they can be major sources of risk,

53
00:02:49.465 --> 00:02:52.265
through leverage the contribution to the,

54
00:02:52.475 --> 00:02:54.025
their contribution, the buildup

55
00:02:54.025 --> 00:02:55.945
of debt in the financial system.

56
00:02:56.495 --> 00:02:58.265
They can also pose liquidity risks.

57
00:02:58.885 --> 00:03:01.925
Uh, and in particular, we've seen Iman, again,

58
00:03:02.345 --> 00:03:05.965
the liquidity risks posed by open-ended real estate funds

59
00:03:06.215 --> 00:03:07.605
where people put in their money.

60
00:03:07.995 --> 00:03:09.125
They have the guarantee

61
00:03:09.125 --> 00:03:11.165
and principle that they can take it out anytime,

62
00:03:11.585 --> 00:03:15.405
but that money is invested in long-term, illiquid assets,

63
00:03:16.185 --> 00:03:17.685
which can't be

64
00:03:18.325 --> 00:03:21.765
realized if there's a run on the fund.

65
00:03:22.425 --> 00:03:23.725
Uh, and,

66
00:03:23.745 --> 00:03:26.445
and sometimes in those cases, the funds actually have

67
00:03:26.445 --> 00:03:28.005
to stop people from taking their money out

68
00:03:28.265 --> 00:03:29.765
by imposing what we call gates.

69
00:03:29.765 --> 00:03:34.405
There are other sources of risks, in the leverage

70
00:03:35.195 --> 00:03:39.005
that, non-bank financial intermediaries can build up

71
00:03:39.535 --> 00:03:41.605
their contribution to the buildup of debt

72
00:03:42.145 --> 00:03:43.285
in the financial system.

73
00:03:43.285 --> 00:03:46.645
Finally, we're also concerned by the interconnectedness

74
00:03:46.915 --> 00:03:49.885
between the non-bank financial intermediaries and the banks

75
00:03:50.265 --> 00:03:52.565
and the risks that they might pose to the banks, which are

76
00:03:52.565 --> 00:03:57.125
after all still the center of our financial system.

77
00:03:57.665 --> 00:04:02.125
And here we have very little real time data on the exposure

78
00:04:02.305 --> 00:04:05.325
of banks to non-bank financial intermediaries,

79
00:04:05.645 --> 00:04:08.245
a rebound in debt securities issuance,

80
00:04:09.005 --> 00:04:12.585
which was significant, especially in Europe,

81
00:04:12.785 --> 00:04:15.985
a rebound in loans as companies recover,

82
00:04:16.495 --> 00:04:20.745
recovered from the Covid crisis, and were,

83
00:04:20.845 --> 00:04:22.505
and were seeking to expand.

84
00:04:23.125 --> 00:04:25.385
Uh, and they were looking,

85
00:04:25.485 --> 00:04:27.345
to non-bank financial intermediaries,

86
00:04:27.345 --> 00:04:28.665
and there were rising valuations.

87
00:04:29.285 --> 00:04:31.425
The markets were going up,

88
00:04:31.485 --> 00:04:34.185
and we had this growth of private credit,

89
00:04:34.805 --> 00:04:38.105
and we had the recovery of the crypto sector,

90
00:04:38.115 --> 00:04:41.705
which began, which had crashed in the winter

91
00:04:41.965 --> 00:04:43.305
of 22

92
00:04:44.045 --> 00:04:46.985
and started to come back, in

93
00:04:47.605 --> 00:04:49.225
the spring of 23.

94
00:04:49.605 --> 00:04:54.135
The rise in interest rates,

95
00:04:54.745 --> 00:04:57.055
which has of course now started to reverse.

96
00:04:57.805 --> 00:04:59.175
It's important to keep that in mind.

97
00:04:59.875 --> 00:05:02.375
The rise in interest rates,

98
00:05:02.755 --> 00:05:05.055
did affect crypto significantly

99
00:05:05.125 --> 00:05:09.175
because crypto is the prototype of a very risky asset.

100
00:05:10.075 --> 00:05:13.615
And as rates go up, we have what we, you, you,

101
00:05:13.685 --> 00:05:16.655
what we call the risk off environment.

102
00:05:17.195 --> 00:05:20.575
Uh, investors pull out of riskier assets.

103
00:05:21.435 --> 00:05:24.335
Uh, and that's part, part of what happened to crypto.

104
00:05:24.585 --> 00:05:26.895
Other things happened to crypto, of course,

105
00:05:27.195 --> 00:05:30.095
and, in the witcher of 22.

106
00:05:30.635 --> 00:05:31.775
Uh, but,

107
00:05:31.915 --> 00:05:34.375
but that was the most important thing As rates started

108
00:05:34.375 --> 00:05:38.535
to go up de-risking, we now have crypto products

109
00:05:39.085 --> 00:05:42.415
that are offered by major financial institutions,

110
00:05:42.505 --> 00:05:46.175
asset managers, that was authorized by the Securities

111
00:05:46.175 --> 00:05:48.415
and Exchange Commission in the United States

112
00:05:48.595 --> 00:05:49.735
at the beginning of this year.

113
00:05:50.435 --> 00:05:53.935
And, it has since been authorized, in Europe.

114
00:05:54.715 --> 00:05:58.605
And we have therefore the, the,

115
00:05:59.225 --> 00:06:03.045
the crypto funds, which are being sold

116
00:06:03.625 --> 00:06:06.765
at a very rapid pace, which are exposing

117
00:06:07.605 --> 00:06:10.885
ordinary investors who wouldn't easily get into the crypto

118
00:06:11.055 --> 00:06:12.325
space, right?

119
00:06:12.985 --> 00:06:16.885
Uh, they're exposing these investors to crypto risks.

120
00:06:17.665 --> 00:06:21.645
Uh, and that is also an interconnection.

121
00:06:21.755 --> 00:06:24.885
This is what, what concerns us, an interconnection

122
00:06:25.235 --> 00:06:28.245
with the non-bank financial intermediary sector,

123
00:06:28.305 --> 00:06:30.125
in particular, the asset managers

124
00:06:30.595 --> 00:06:34.365
that are issuing those crypto products.

125
00:06:34.625 --> 00:06:38.245
We are concerned that crypto market disturbances could

126
00:06:38.545 --> 00:06:41.245
spread to traditional finance, in particular the banks.

127
00:06:41.625 --> 00:06:44.405
And if you look at the United States, the, you,

128
00:06:44.465 --> 00:06:47.765
you have major examples in the failures

129
00:06:47.765 --> 00:06:51.685
of Silicon Valley Bank, signature Bank and,

130
00:06:51.865 --> 00:06:53.045
and Silver Gate Bank.

131
00:06:53.375 --> 00:06:57.765
After the crash of FTX in the OT of 2022,

132
00:06:58.795 --> 00:07:02.685
investors discovered that, for example,

133
00:07:02.995 --> 00:07:04.125
Silicon Valley Bank.

134
00:07:04.125 --> 00:07:06.685
And one of the problems of Silicon Valley Bank was

135
00:07:06.685 --> 00:07:10.045
that it was holding major deposits from the crypto sector.

136
00:07:10.785 --> 00:07:14.365
Uh, and in fact, when si, Silicon Valley Bank went under

137
00:07:15.035 --> 00:07:18.325
that then affected the, so-called stable coin

138
00:07:18.835 --> 00:07:22.285
that was issued by one of its major depositors circle,

139
00:07:22.615 --> 00:07:25.925
which had over $3 billion in Silicon Valley Bank.

140
00:07:26.305 --> 00:07:30.405
So you had a direct connection there, to, from the bank

141
00:07:31.025 --> 00:07:34.005
to the crypto sector and the crypto sector to the bank.

142
00:07:34.425 --> 00:07:36.445
Uh, and similarly, silver Gate

143
00:07:36.545 --> 00:07:40.925
and Signature Bank, both American banks, again, were, had

144
00:07:40.925 --> 00:07:44.565
to close down because their, their exposures

145
00:07:44.905 --> 00:07:46.365
to the crypto sector

146
00:07:46.905 --> 00:07:50.085
and things that were going wrong in the crypto sector in the

147
00:07:50.085 --> 00:07:51.885
winter of 20 22, 23.

148
00:07:52.805 --> 00:07:54.945
So we are concerned with that.

149
00:07:55.245 --> 00:07:59.185
And, with the banks that are acting as

150
00:08:00.315 --> 00:08:03.925
off-ramps and on-ramps for the crypto sector,

151
00:08:04.215 --> 00:08:06.325
we're also concerned with stable coins.

152
00:08:06.795 --> 00:08:10.445
so-called stable coins that are issued, with

153
00:08:11.005 --> 00:08:13.445
supposed backing from liquid assets.

154
00:08:13.555 --> 00:08:18.245
There's always questions about whether those issuers,

155
00:08:18.265 --> 00:08:21.885
in particular tethered, longstanding controversy as

156
00:08:21.885 --> 00:08:25.405
to whether the most important of these stable coins.

157
00:08:25.405 --> 00:08:30.205
Tether is really backed by liquid US government securities.

158
00:08:30.955 --> 00:08:33.725
They say they don't have a proper auditing process.

159
00:08:34.385 --> 00:08:37.565
Um, so it's hard to tell, what's going on there.

160
00:08:37.985 --> 00:08:39.245
Uh, but the point is

161
00:08:39.245 --> 00:08:41.965
that these stable coins are highly concentrated.

162
00:08:41.965 --> 00:08:43.845
There are only a few of them that really

163
00:08:44.715 --> 00:08:46.965
play a major role in the financial system.

164
00:08:47.825 --> 00:08:51.075
And, they hold in principle,

165
00:08:51.075 --> 00:08:53.875
at least their backing is in financial assets.

166
00:08:54.175 --> 00:08:56.565
If there's a run on a stable coin,

167
00:08:56.795 --> 00:08:58.685
it's like a run on a money market fund.

168
00:08:58.685 --> 00:09:01.405
They're very similar to money market funds, actually,

169
00:09:01.925 --> 00:09:04.805
a run on a stable coin, people wanting to get fiat money

170
00:09:05.545 --> 00:09:09.605
in exchange for their stable coin would force the issuers

171
00:09:09.605 --> 00:09:12.645
of the stable coin to sell the securities

172
00:09:12.835 --> 00:09:15.165
that are backing the stable coin,

173
00:09:15.625 --> 00:09:19.125
and that then could have a major knock on effect on the

174
00:09:19.125 --> 00:09:22.925
markets and those securities, which then could be a threat

175
00:09:22.925 --> 00:09:23.965
to financial stability.

176
00:09:24.345 --> 00:09:29.205
In the European Union, about 60% of fund assets are managed

177
00:09:29.205 --> 00:09:31.605
by companies that are owned by banks.

178
00:09:32.935 --> 00:09:34.955
And there's a contrast there with the United States

179
00:09:35.445 --> 00:09:39.595
where 80% of asset management is freestanding,

180
00:09:39.895 --> 00:09:41.195
not associated with banks.

181
00:09:41.695 --> 00:09:42.795
Now, what's the difference there?

182
00:09:42.795 --> 00:09:44.635
And what, what's the importance of that?

183
00:09:45.015 --> 00:09:49.475
And that, that's, you can most easily see in an example,

184
00:09:49.855 --> 00:09:54.435
in the summer of 2007, try to look back

185
00:09:54.435 --> 00:09:56.715
that far, but these risks recur.

186
00:09:57.415 --> 00:10:01.995
Uh, the first major event in the financial crisis

187
00:10:02.055 --> 00:10:05.935
of 2007, 2008, was the

188
00:10:06.605 --> 00:10:10.935
failure of the decision by one

189
00:10:10.935 --> 00:10:15.305
of the biggest European banks to close three of its funds

190
00:10:15.975 --> 00:10:18.345
because they were in trouble.

191
00:10:18.935 --> 00:10:23.225
Okay? Now that is what we call a step in risk. Okay?

192
00:10:23.725 --> 00:10:27.965
The bank owns a fund, the bank is acting

193
00:10:28.065 --> 00:10:30.045
as an asset manager, right?

194
00:10:30.825 --> 00:10:33.165
Uh, but the fund gets in trouble

195
00:10:33.785 --> 00:10:37.605
and the bank has to step in either to rescue it

196
00:10:38.025 --> 00:10:40.125
or to close it down and liquidate the assets

197
00:10:40.185 --> 00:10:42.645
and distribute them to the, distribute

198
00:10:42.645 --> 00:10:45.685
what there is there to the fund holders.

199
00:10:45.995 --> 00:10:48.005
That is something that can happen

200
00:10:49.225 --> 00:10:50.725
on a much more general scale.

201
00:10:51.425 --> 00:10:55.125
And it's not just a risk to the balance sheets of the banks,

202
00:10:55.585 --> 00:11:00.005
but it's also a risk, to the reputation of the banks.

203
00:11:00.625 --> 00:11:02.325
And that's very important in our system,

204
00:11:02.675 --> 00:11:06.645
that banks have a reputation for stability and so forth.

205
00:11:07.145 --> 00:11:11.325
If that's endangered by their, by problems with funds

206
00:11:11.715 --> 00:11:15.685
that they are, that they are managing in their role

207
00:11:15.825 --> 00:11:18.885
as asset managers, then that's a problem

208
00:11:18.985 --> 00:11:20.285
for the entire financial system.

209
00:11:20.285 --> 00:11:24.895
Private finance may be ultimately financed

210
00:11:24.915 --> 00:11:27.855
by banks, but often goes through and,

211
00:11:27.955 --> 00:11:31.295
and the loans are extended from insurance companies

212
00:11:31.295 --> 00:11:32.935
or pension funds,

213
00:11:33.155 --> 00:11:37.815
or other non-bank financial intermediaries, okay?

214
00:11:37.995 --> 00:11:39.095
And they're direct loans

215
00:11:39.555 --> 00:11:42.255
to non-financial corporations typically,

216
00:11:42.795 --> 00:11:46.775
and they're typically to smaller firms, to riskier firms,

217
00:11:47.125 --> 00:11:48.815
riskier loans, okay?

218
00:11:49.885 --> 00:11:54.565
They're, they claim the, the lenders claim

219
00:11:54.625 --> 00:11:58.765
to do this kind of due diligence that banks do,

220
00:11:58.985 --> 00:12:03.845
for their borrowers, but you can't be entirely sure of that.

221
00:12:04.105 --> 00:12:06.085
And that then poses risks

222
00:12:06.745 --> 00:12:09.965
to the non-bank financial intermediation system

223
00:12:10.395 --> 00:12:15.245
that is intermediating this flow of credit,

224
00:12:15.865 --> 00:12:18.965
which may not have the same source of covenants,

225
00:12:18.985 --> 00:12:23.605
for example, risk, modifying factors

226
00:12:24.155 --> 00:12:26.245
that apply in bank loans.

227
00:12:26.825 --> 00:12:30.845
And this is a rapidly growing sector, partly

228
00:12:30.845 --> 00:12:35.045
because the insurance companies, the pension funds,

229
00:12:35.705 --> 00:12:40.245
a lot of asset managers are looking for higher returns.

230
00:12:40.585 --> 00:12:42.845
And these loans, these private credit loans

231
00:12:43.505 --> 00:12:45.405
do offer higher returns,

232
00:12:45.905 --> 00:12:49.725
and they're often priced in that sense, very aggressively,

233
00:12:49.815 --> 00:12:53.945
which is another risk as to whether the borrowers ultimately

234
00:12:54.565 --> 00:12:55.985
can handle that burden.

235
00:12:56.685 --> 00:13:00.825
So, private credit is now probably over 3 trillion

236
00:13:01.525 --> 00:13:03.215
in Europe, right?

237
00:13:03.915 --> 00:13:06.375
And that's a, you know, that's a non-trivial number.

238
00:13:06.995 --> 00:13:10.615
Uh, and the exposures there are quite important.

239
00:13:10.685 --> 00:13:13.495
There's several things that are constantly on our minds from

240
00:13:13.495 --> 00:13:14.815
the regulatory point of view.

241
00:13:15.435 --> 00:13:19.855
One is liquidity and for example, with money market funds.

242
00:13:20.915 --> 00:13:23.975
And there, there are issues that

243
00:13:24.485 --> 00:13:27.495
were supposedly dealt with in the European Union

244
00:13:28.115 --> 00:13:31.375
by a regulation in 2017.

245
00:13:32.275 --> 00:13:35.175
We maintain that that regulation is insufficient.

246
00:13:35.715 --> 00:13:38.335
We have proposed that the European Systemic Risk Board,

247
00:13:38.715 --> 00:13:42.095
we have proposed a number of what we think are important

248
00:13:42.675 --> 00:13:43.895
policy measures there.

249
00:13:44.395 --> 00:13:46.975
And so far that has not progressed.

250
00:13:47.515 --> 00:13:50.255
Uh, the European Commission effectively are waiting

251
00:13:50.755 --> 00:13:52.655
for a new commission to come in.

252
00:13:53.295 --> 00:13:57.655
I think the delay in dealing with the risks

253
00:13:57.675 --> 00:14:00.815
and money market funds that we saw exhibited in March

254
00:14:00.835 --> 00:14:03.895
of 2020, despite the regulation

255
00:14:04.315 --> 00:14:09.135
of 2017, that is a risk, set of risks that,

256
00:14:09.635 --> 00:14:12.445
that worries us,

257
00:14:13.325 --> 00:14:15.655
otherwise what's front

258
00:14:15.655 --> 00:14:18.335
and center, in our concerns.

259
00:14:19.575 --> 00:14:23.265
Private credit indeed, the

260
00:14:24.125 --> 00:14:27.935
overall interconnections between the banking sector

261
00:14:28.115 --> 00:14:32.055
and the non-bank sector, those are growing and growing,

262
00:14:32.275 --> 00:14:35.735
and we have very little ability

263
00:14:36.235 --> 00:14:38.175
to monitor those interconnections.

264
00:14:38.515 --> 00:14:42.535
The authorities are more concerned now

265
00:14:42.845 --> 00:14:46.935
with non-Bank financial intermediation than they used to be.

266
00:14:47.595 --> 00:14:50.855
And it is one of the big subjects that comes up

267
00:14:50.855 --> 00:14:53.645
In all those meetings in Basel and elsewhere.

268
00:14:54.105 --> 00:14:57.725
Uh, and the international conferences that I participate in

269
00:14:57.945 --> 00:15:01.485
and that sort of thing, non-Bank financial intermediation

270
00:15:02.305 --> 00:15:06.885
has, I won't say replaced banks as a source

271
00:15:06.885 --> 00:15:08.885
of concern, but

272
00:15:09.745 --> 00:15:13.525
but is certainly top of the list for policy makers.

273
00:15:13.945 --> 00:15:15.965
And part of that, of course, is the connections,

274
00:15:16.025 --> 00:15:19.845
as I've said, with the banks that provide leverage

275
00:15:20.185 --> 00:15:22.765
to the not lending to debt

276
00:15:22.865 --> 00:15:24.605
for the non-bank financial intermediaries.

Quick Answers

Regulatory Risks in Banking and Non-Banking Intermediaries

00:00:00 - Banks have deposit liabilities and assets in the form of loans and an equity capital base that's quite subject to regulatory minimum. Whereas most non-bank financial intermediaries, except for money market funds and pension funds and insurers don't have significant balance sheets. Asset managers, in particular channel investors funds into assets owned by those investors. The risks associated with those assets are born

00:00:33 - by the non-bank financial intermediaries. On the other hand, the non-bank financial intermediaries are subject to little or no regulation, and they have no backstops in the form of central banks as lenders of last resort as we put it. and they can fail. A big example, of course, was a IG, the big insurer in, the crisis of 2008, which was one of the biggest bailouts ever, right?

00:01:06 - which failed, and required, not a bailout. Nobody was gonna step into, bail them out, but it, and it didn't require, it implied a lot of losses for those banks that extended loans to it. The banks didn't know each of them what Arch Chagos was borrowing from the others. And so you had a knock on effect in particular

Risks and Regulatory Challenges of Non-Bank Financial Intermediaries

00:01:37 - maybe more to Argos. And that contributed to the downfall of Credit Sus, in March, 2023. The central banks may be forced to intervene as market makers of last resort because although they won't want to support the non-bank financial intermediaries themselves, they don't want markets to freeze up. and you could see that happen in, for example, the dash

00:02:09 - of money market funds, for example, got into deep trouble and the central banks did have to step in to deal with them, as well as corporate bond funds, for example. So the problem with the non-bank financial intermediaries from the point of view of the authorities is that they're not really very much regulated. Money market funds are some, but, but otherwise there's not much, and, and yet they compose major dangers to the financial system.

00:02:40 - intermediaries channel funds from savings into investment, and they diversify risks, but they can be major sources of risk, through leverage the contribution to the, their contribution, the buildup of debt in the financial system. They can also pose liquidity risks. and in particular, we've seen Iman, again, the liquidity risks posed by open-ended real estate funds where people put in their money. They have the guarantee

Risks of Non-Bank Financial Intermediaries and Their Interconnectedness with Banks

00:03:11 - but that money is invested in long-term, illiquid assets, which can't be realized if there's a run on the fund. and, and sometimes in those cases, the funds actually have to stop people from taking their money out by imposing what we call gates. There are other sources of risks, in the leverage that, non-bank financial intermediaries can build up

00:03:42 - in the financial system. Finally, we're also concerned by the interconnectedness between the non-bank financial intermediaries and the banks and the risks that they might pose to the banks, which are after all still the center of our financial system. And here we have very little real time data on the exposure of banks to non-bank financial intermediaries, a rebound in debt securities issuance, which was significant, especially in Europe,

00:04:16 - recovered from the Covid crisis, and were, and were seeking to expand. and they were looking, to non-bank financial intermediaries, and there were rising valuations. The markets were going up, and we had this growth of private credit, and we had the recovery of the crypto sector, which began, which had crashed in the winter of 22

Impact of Rising Interest Rates on Cryptocurrency Markets

00:04:47 - the spring of 23. The rise in interest rates, which has of course now started to reverse. It's important to keep that in mind. The rise in interest rates, did affect crypto significantly because crypto is the prototype of a very risky asset. And as rates go up, we have what we, you, you, what we call the risk off environment.

00:05:21 - and that's part, part of what happened to crypto. Other things happened to crypto, of course, and, in the witcher of 22. but, but that was the most important thing As rates started to go up de-risking, we now have crypto products that are offered by major financial institutions, asset managers, that was authorized by the Securities and Exchange Commission in the United States

00:05:50 - And, it has since been authorized, in Europe. And we have therefore the, the, the crypto funds, which are being sold at a very rapid pace, which are exposing ordinary investors who wouldn't easily get into the crypto space, right? they're exposing these investors to crypto risks. and that is also an interconnection.

Interconnected Risks: Crypto's Impact on Traditional Banking

00:06:25 - with the non-bank financial intermediary sector, in particular, the asset managers that are issuing those crypto products. We are concerned that crypto market disturbances could spread to traditional finance, in particular the banks. And if you look at the United States, the, you, you have major examples in the failures of Silicon Valley Bank, signature Bank and,

00:06:53 - After the crash of FTX in the OT of 2022, investors discovered that, for example, Silicon Valley Bank. And one of the problems of Silicon Valley Bank was that it was holding major deposits from the crypto sector. and in fact, when si, Silicon Valley Bank went under that then affected the, so-called stable coin that was issued by one of its major depositors circle,

00:07:26 - So you had a direct connection there, to, from the bank to the crypto sector and the crypto sector to the bank. and similarly, silver Gate and Signature Bank, both American banks, again, were, had to close down because their, their exposures to the crypto sector and things that were going wrong in the crypto sector in the winter of 20 22, 23.

Concerns Surrounding Stable Coins and Financial Stability

00:07:55 - And, with the banks that are acting as off-ramps and on-ramps for the crypto sector, we're also concerned with stable coins. so-called stable coins that are issued, with supposed backing from liquid assets. There's always questions about whether those issuers, in particular tethered, longstanding controversy as to whether the most important of these stable coins.

00:08:30 - They say they don't have a proper auditing process. so it's hard to tell, what's going on there. but the point is that these stable coins are highly concentrated. There are only a few of them that really play a major role in the financial system. And, they hold in principle, at least their backing is in financial assets. If there's a run on a stable coin,

00:08:58 - They're very similar to money market funds, actually, a run on a stable coin, people wanting to get fiat money in exchange for their stable coin would force the issuers of the stable coin to sell the securities that are backing the stable coin, and that then could have a major knock on effect on the markets and those securities, which then could be a threat to financial stability. In the European Union, about 60% of fund assets are managed

Risks of Bank-Associated Asset Management

00:09:32 - And there's a contrast there with the United States where 80% of asset management is freestanding, not associated with banks. Now, what's the difference there? And what, what's the importance of that? And that, that's, you can most easily see in an example, in the summer of 2007, try to look back that far, but these risks recur. the first major event in the financial crisis

00:10:06 - failure of the decision by one of the biggest European banks to close three of its funds because they were in trouble. Okay? Now that is what we call a step in risk. Okay? The bank owns a fund, the bank is acting as an asset manager, right? but the fund gets in trouble

00:10:38 - or to close it down and liquidate the assets and distribute them to the, distribute what there is there to the fund holders. That is something that can happen on a much more general scale. And it's not just a risk to the balance sheets of the banks, but it's also a risk, to the reputation of the banks. And that's very important in our system, that banks have a reputation for stability and so forth.

Risks in Non-Bank Financial Intermediation

00:11:11 - that they are, that they are managing in their role as asset managers, then that's a problem for the entire financial system. Private finance may be ultimately financed by banks, but often goes through and, and the loans are extended from insurance companies or pension funds, or other non-bank financial intermediaries, okay?

00:11:39 - to non-financial corporations typically, and they're typically to smaller firms, to riskier firms, riskier loans, okay? They're, they claim the, the lenders claim to do this kind of due diligence that banks do, for their borrowers, but you can't be entirely sure of that. And that then poses risks to the non-bank financial intermediation system

00:12:15 - which may not have the same source of covenants, for example, risk, modifying factors that apply in bank loans. And this is a rapidly growing sector, partly because the insurance companies, the pension funds, a lot of asset managers are looking for higher returns.

Challenges in Private Credit and Regulatory Oversight

00:12:43 - do offer higher returns, and they're often priced in that sense, very aggressively, which is another risk as to whether the borrowers ultimately can handle that burden. So, private credit is now probably over 3 trillion in Europe, right? And that's a, you know, that's a non-trivial number. and the exposures there are quite important.

00:13:13 - the regulatory point of view. One is liquidity and for example, with money market funds. And there, there are issues that were supposedly dealt with in the European Union by a regulation in 2017. We maintain that that regulation is insufficient. We have proposed that the European Systemic Risk Board, we have proposed a number of what we think are important

00:13:44 - And so far that has not progressed. the European Commission effectively are waiting for a new commission to come in. I think the delay in dealing with the risks and money market funds that we saw exhibited in March of 2020, despite the regulation of 2017, that is a risk, set of risks that, that worries us,

Growing Concerns Over Non-Bank Financial Intermediation

00:14:15 - and center, in our concerns. Private credit indeed, the overall interconnections between the banking sector and the non-bank sector, those are growing and growing, and we have very little ability to monitor those interconnections. The authorities are more concerned now with non-Bank financial intermediation than they used to be.

00:14:50 - In all those meetings in Basel and elsewhere. and the international conferences that I participate in and that sort of thing, non-Bank financial intermediation has, I won't say replaced banks as a source of concern, but but is certainly top of the list for policy makers. And part of that, of course, is the connections, as I've said, with the banks that provide leverage

00:15:22 - for the non-bank financial intermediaries.

Faculti AI can make mistakes

Research

Policy

Analysis

Data

Originals

Explainers

Podcasts

Watch the latest episode of The Exchange – the show where influential policymakers and leading researchers engage in insightful discussions shaping the future.

Episode: Brazil's Economic Resilience