- The FED NY paper discusses the deep interconnection between banks and nonbank financial institutions (NBFIs). It challenges the perception that these entities operate independently or as substitutes, showing instead that their activities and risks are intricately linked.
- Interconnected Activities: The growth of NBFIs depends heavily on bank funding and liquidity support; Banks have shifted certain activities to NBFIs due to regulatory changes but continue to support these activities indirectly.
- Transformation of Risks: Loans: Corporate and mortgage loans are increasingly held by NBFIs, but banks maintain exposure through senior loans and collateralized loans; Short-Term Funding: NBFIs dominate securitization and mortgage servicing, yet rely on banks for funding through loans, warehouse financing, and commercial paper; Contingent Funding: Banks provide crucial liquidity support for NBFIs to meet margin requirements in derivatives trading.
- Example in Private Credit: The sale of PacWest bank’s loan portfolio to Ares Management, financed partly by Barclays, illustrates how bank risks remain present in the system through NBFIs.
- Regulatory Implications: The interconnectedness suggests that risks are repackaged rather than eliminated, necessitating a holistic regulatory approach; Both banks and NBFIs are exposed to each other, highlighting potential channels for shock transmission during financial crises.
