Maintaining a steady flow of liquidity in a constantly changing global atmosphere
The funding and liquidity landscape for financial institutions has undergone significant changes over recent years, with implications for the availability of liquidity for Non-Bank Financial Institutions (NBFIs). This shift is shaping the financial system's stability through interconnected risks and leverage.
For NBFIs, the growth has been substantial due to technological advances, demographic shifts, and tighter bank regulation. These factors have pushed riskier or leveraged activities out of banks into the less-regulated NBFI sector, also known as shadow banking. This shift has increased liquidity demand and inherent fragility due to liquidity transformation needs within NBFIs.
Funding dynamics for NBFIs show a decline in traditional debt securities financing but a significant rise in credit lines from banks since around 2012. This highlights increasing dependency on bank credit lines as a funding source for NBFIs, intertwining their liquidity with banks' funding conditions.
Regulatory changes are underway, with agencies like the US Consumer Financial Protection Bureau considering raising thresholds to reduce compliance burdens on smaller nonbanks, focusing regulatory resources on larger entities. NBFIs are also under intensified focus for leverage risks by policymakers to address how excessive leverage in NBFIs can threaten overall stability.
Banks, on the other hand, have seen a structural change as riskier activities moved out to NBFIs post-global financial crisis. This has changed banks' liquidity and funding roles, with increasing emphasis on real-time cash management, scalability, and efficiency to optimize liquidity as market demands rise.
The growing interconnectivity between banks and NBFIs via credit lines and funding dependencies raises systemic risk concerns. Increased leverage and liquidity transformation in NBFIs create fragile conditions, as their reliance on short-term funding and redemption pressures can propagate financial stress.
The Bank of England aims to incentivize banks and NBFIs to participate actively in private sector funding markets, ensuring continued provision of financial services by NBFIs, avoiding unsustainable risk-taking and leverage, and supporting the financial system's ability to self-manage increased liquidity demands and self-stabilize in severe but plausible stresses.
Market participants, including NBFIs, should maintain their own liquidity resilience to allow core markets to self-stabilize in response to shocks. The resilience of core markets to stress remains crucial, as they support the provision of services to households and businesses. Core private sector funding markets, which underpin a wide set of transactions, need to be resilient to stress.
The overarching goal in the new funding and liquidity landscape is to deliver the Bank of England's core statutory objectives of monetary and financial stability. Nathanaël Benjamin, Executive Director of Financial Stability Strategy at the Bank of England, spoke on this topic at an OMFIF-Bank of England lecture, and interested readers can find the full speech and the lecture video on the OMFIF website. Central bank reserves play a key role in how liquidity flows through the system, as the safest and most liquid of financial assets and the ultimate means of settlement.
This change is moving away from a post-2008 financial crisis monetary policy stance of very low interest rates and very large central bank balance sheets. Within the overarching goal, three objectives can be set: ensuring continued provision of financial services by NBFIs, avoiding unsustainable risk-taking and leverage, and supporting the financial system's ability to self-manage increased liquidity demands and self-stabilize in severe but plausible stresses. The Bank of England seeks to ensure that liquidity can flow around the financial system to get where it is needed most.
- Policymakers are focusing on NBFIs due to increased leveraged activities, aiming to address the risk they pose to overall financial stability.
- Artificial intelligence (AI) may provide valuable insights for sustainable finance by predicting riskier investments in the business world, helping to manage liquidity and reduce systemic risks.
- The public should be aware of the growing interconnectivity between banks and NBFIs, as this raises systemic risk concerns in the area of sustainable finance and investing.
- Data analytics can aid regulatory agencies in monitoring the financing activities of NBFIs to ensure compliance and maintain a stable financial system, especially regarding leverage risks.
- As financial institutions adapt to the changing landscape, they should prioritize strategic investments in technology and efficiency measures to optimize liquidity, promote sustainable finance practices, and reduce risks.
