In the 20th century, banks formed the foundation of the world’s financial system. no more. Recent events in the UK should dispel any doubts about the changes that have taken place in the financial industry over the past few decades.
The Bank of England has made two key interventions in the past two weeks to support financial stability. Neither were directly involved with the bank. After the government’s proposal to cut income taxes for high-income earners was subsequently abandoned, the central bank hastily released up to £65bn ($113bn) of government bonds in response to a long period of gold and silver violence. Expanded program to buy. He has also announced that, in partnership with the UK Treasury, he will provide £40bn of emergency funding to energy companies struggling to meet margin calls.
Together, they reflect the evolution at the heart of the global financial order. The system is no longer based on banks. Rather, it is increasingly centered around the market. This is an important difference and has broad implications.
When banks took on the role of gatekeepers, central bankers lived simpler lives. To meet their obligations to ensure financial stability, they acted as the lender of last resort to the banks. This is the role it played extensively during the global financial crisis. By limiting the number of banking licenses, they maintained control of the sector and thus the financial system.
Over the years, however, lenders have ceded market share to various financial institutions. Twenty years ago, the bank held 46% of the world’s financial assets, according to Financial Stability Board data. Now he’s down to 38%. By contrast, non-bank financial institutions, such as insurance companies and pension funds, accounted for 41% to 48% in 2002. This trend was briefly reversed during the 2008 global financial crisis, but has resumed its previous course. Accelerate immediately after that.
Non-bank institutions rely on the wholesale market to finance their operations, particularly government bonds that act as collateral to enable borrowing. Many use the same collateral to support their hedging programs.
“In the absence of further action, there is good reason to believe that we will see more frequent periods of dysfunction in the very markets on which households and businesses are increasingly dependent.”
Andrew Hauser, Bank of England
The system has many benefits and gives financial institutions instant access to financing and hedging solutions with the security of safe and liquid assets. But unfortunately there is a tendency towards procyclicality. Collateral requirements can rise sharply during periods of market turmoil, which could cause further turmoil if it leads to forced selling, as we saw in the UK last week.
In the past, banks may have stepped in to manage the impact, but largely due to stricter rules on trading and capital after the financial crisis, bank balance sheets have grown very large relative to the size of the collateral market. stay small. For example, in the UK, the market maker’s assets in UK government bonds have fallen by 25% since 2008, while at the same time inventories of outstanding UK government bonds have increased by a factor of 2.7.
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