Liquidity crisis

EBA observes an increase in the asset encumbrance ratio amidst extensive use of central bank facilities

Retrieved on:

Monday, January 18, 2021

Money, Finance, Economy, Banking, Banks, Central bank, Financial markets, Asset and liability management, Liquidity crisis

As COVID-19 spread across Europe and activity in primary markets froze, banks made extensive use of central bank liquidity facilities to build precautionary liquidity buffers.

Key Points:

As COVID-19 spread across Europe and activity in primary markets froze, banks made extensive use of central bank liquidity facilities to build precautionary liquidity buffers.
Overview of key figures
The extensive use of the extraordinary central bank liquidity facilities in 2020 has driven up the share of central bank funding over total sources of encumbrance.
In contrast, the attractive conditions of central bank facilities have led many banks to reduce their reliance on covered bonds.
Although the recent increase in the asset encumbrance ratio is not a concern by itself, banks capacity to further make use of central bank funding when necessary should be monitored.

Isabel Schnabel: COVID-19 and the liquidity crisis of non-banks: lessons for the future

Retrieved on:

Friday, November 20, 2020

Finance, Money, Economy, Financial markets, Systemic risk, Banking, United States housing bubble, Financial regulation, Liquidity risk, Liquidity crisis, Market liquidity, Money market fund

SPEECHCOVID-19 and the liquidity crisis of non-banks: lessons for the futureSpeech by Isabel Schnabel, Member of the Executive Board of the ECB, Financial Stability Conference on “Stress, Contagion, and Transmission” organised by the Federal Reserve Bank of Cleveland and the Office of Financial ResearchTighter regulation and higher capital ratios have been key factors enabling banks to act as shock absorbers rather than shock amplifiers during the coronavirus (COVID-19) pandemic.

Key Points:

SPEECH

COVID-19 and the liquidity crisis of non-banks: lessons for the future

Speech by Isabel Schnabel, Member of the Executive Board of the ECB, Financial Stability Conference on “Stress, Contagion, and Transmission” organised by the Federal Reserve Bank of Cleveland and the Office of Financial Research

Tighter regulation and higher capital ratios have been key factors enabling banks to act as shock absorbers rather than shock amplifiers during the coronavirus (COVID-19) pandemic.
At the same time, the crisis has been a stark reminder that there are still considerable vulnerabilities in the financial sector.
In particular, there has been a divergence between the comparatively lean regulation of the non-bank financial sector and its increasing role in financial intermediation across the globe.
This divergence has measurably augmented the risks of perilous macro-financial feedback loops, which may also affect the conduct of monetary policy.

The expansion of the non-bank sector

The financial sector landscape in the euro area has changed significantly over the past decade.
Today, non-bank credit accounts for around a third of firms total external debt financing, twice the share in 2008 (see left chart slide2).
And the share of marketable debt securities in external financing has also doubled in the euro area since the global financial crisis (see right chart slide 2).
In a similar vein, while the regulatory responses to the global financial crisis have succeeded in making the banking sector more resilient, the policy framework for the non-bank financial sector is far less developed.
In particular, the macroprudential framework for the non-bank financial sector is still in its infancy, which limits the ability of authorities to address emerging risks and vulnerabilities.

The role of non-banks during the spring market turmoil

These regulatory gaps were clearly visible during the market turmoil in spring.
Diverging corporate sector bond spreads and credit default swap (CDS) spreads signalled that bond spreads widened beyond the rise in perceived default risk (see left chart slide 4).
[6] In the spring, however, the demand for liquidity was unusually high.
High-yield corporate bond funds, in particular, experienced significant cumulative outflows of more than 10% of their assets under management (see right chart slide6).
But evidence suggests that investment funds sold significantly more securities than those that end-investors located in the euro area withdrew.
This suggests that other factors are likely to have amplified the procyclical selling by investment funds.

Increasing liquidity risk

The first is the mismatch between asset liquidity and redemption policies.
[7] As a result, fund managers sought liquidity when the capacity of markets to provide that liquidity had diminished sharply, resulting in forced asset sales and the amplification of adverse market dynamics.
Although the extent of liquidity shortfalls is likely to have varied substantially at the fund level, outflows clearly exceeded median cash holdings for all types of corporate bond funds (see right chart slide 7).

Leverage as an amplifier of market stress

[8] A recent ECB study finds that investors in leveraged funds tend to respond more strongly to deteriorating fund returns, adding to volatility in a bear market.
[9] Tentative evidence of the sharp sell-off in March corroborates the view that leverage has probably also been a source of procyclicality during the pandemic.
Investment strategies reliant on low market volatility have possibly played a significant role in this.
These volatility-targeting funds typically use leverage when market volatility is below target, as it was before the pandemic, and they have to liquidate leveraged positions when market volatility surges.
As volatility spiked and diversification benefits from cross-asset exposures vanished, volatility-targeting investors were prompted to sell assets and reduce leverage (see right chart slide 8).

Margin calls and demand for liquidity

The third factor relates to margin calls.
But they also increase liquidity risk, particularly when liquid asset holdings are inadequate.
[12] To meet margin calls, some euro area insurers and pension funds that make extensive use of interest rate swaps and foreign exchange derivatives liquidated shares held in money market funds (MMFs).
[13] There was a striking correlation between margin calls and MMF outflows over the entire period of market stress (see right chart slide9).

Systemic risks due to interdependencies

Insurance corporations, for example, not only rely heavily on MMFs for their liquidity management, they also hold over 25% of their assets in investment fund shares.
This meant that pressure on investment funds in March negatively affected insurers profitability.
[18] While some investment funds and MMFs took exceptional measures to cope with their liquidity stress, these were not sufficient to prevent systemic stress.
Some investment funds used quantity-based measures, such as the suspension of redemptions and redemption gates to address liquidity issues.
Others used price-based measures, such as swing pricing and redemption fees, to ensure trading costs were borne by redeeming investors.
Widespread suspensions may also have had adverse effects on the confidence in the wider financial sector, possibly amplifying risk-off behaviour.

The role of monetary policy in stabilising financial markets

Forceful monetary policy action, on both sides of the Atlantic, ultimately filled the void that was left by asset managers and regulators having limited liquidity management tools to curb systemic stress.
The fast rise of the non-bank sector, however, meant that traditional monetary policy tools, such as increasing the money supply to banks and accepting broader collateral, were not sufficient.
They either provide liquidity directly to non-banks that is, they expand their role as lender of last resort or they purchase large quantities of illiquid assets.
Allowing funds to become monetary policy counterparties, however, creates major operational, supervisory and regulatory challenges that cannot be solved overnight.
The announcement of the PEPP had a strong and immediate stabilising effect on financial markets.

Fixing the fault lines for non-banks

[22] Indeed, many funds started to take up liquidity risk soon after the March turmoil.
[23] Ensuring that central banks can pursue their mandates without risking financial stability requires a rethink of our current prudential framework.
It must be strengthened from a systemic risk perspective to ensure that it can be an effective first line of defence.
Without these buffers, they are unable to respond to short-notice redemptions or margin calls without engaging in forced asset sales.
We should consider giving authorities a greater ability to provide direction on the use of liquidity management policies by fund managers.
This includes a review of the liquidity requirements for MMFs and their portfolio composition, especially for LVNAV funds given their vulnerability to liquidity shocks.

Conclusion

Isabel Schnabel: COVID-19 and the liquidity crisis of non-banks: lessons for the future

Retrieved on:

Friday, November 20, 2020

Finance, Money, Economy, Financial markets, Systemic risk, Banking, United States housing bubble, Financial regulation, Liquidity risk, Liquidity crisis, Market liquidity, Money market fund

SPEECHCOVID-19 and the liquidity crisis of non-banks: lessons for the futureSpeech by Isabel Schnabel, Member of the Executive Board of the ECB, Financial Stability Conference on “Stress, Contagion, and Transmission” organised by the Federal Reserve Bank of Cleveland and the Office of Financial ResearchTighter regulation and higher capital ratios have been key factors enabling banks to act as shock absorbers rather than shock amplifiers during the coronavirus (COVID-19) pandemic.

Key Points:

SPEECH

COVID-19 and the liquidity crisis of non-banks: lessons for the future

Speech by Isabel Schnabel, Member of the Executive Board of the ECB, Financial Stability Conference on “Stress, Contagion, and Transmission” organised by the Federal Reserve Bank of Cleveland and the Office of Financial Research

Tighter regulation and higher capital ratios have been key factors enabling banks to act as shock absorbers rather than shock amplifiers during the coronavirus (COVID-19) pandemic.
At the same time, the crisis has been a stark reminder that there are still considerable vulnerabilities in the financial sector.
In particular, there has been a divergence between the comparatively lean regulation of the non-bank financial sector and its increasing role in financial intermediation across the globe.
This divergence has measurably augmented the risks of perilous macro-financial feedback loops, which may also affect the conduct of monetary policy.

The expansion of the non-bank sector

The financial sector landscape in the euro area has changed significantly over the past decade.
Today, non-bank credit accounts for around a third of firms total external debt financing, twice the share in 2008 (see left chart slide2).
And the share of marketable debt securities in external financing has also doubled in the euro area since the global financial crisis (see right chart slide 2).
In a similar vein, while the regulatory responses to the global financial crisis have succeeded in making the banking sector more resilient, the policy framework for the non-bank financial sector is far less developed.
In particular, the macroprudential framework for the non-bank financial sector is still in its infancy, which limits the ability of authorities to address emerging risks and vulnerabilities.

The role of non-banks during the spring market turmoil

These regulatory gaps were clearly visible during the market turmoil in spring.
Diverging corporate sector bond spreads and credit default swap (CDS) spreads signalled that bond spreads widened beyond the rise in perceived default risk (see left chart slide 4).
[6] In the spring, however, the demand for liquidity was unusually high.
High-yield corporate bond funds, in particular, experienced significant cumulative outflows of more than 10% of their assets under management (see right chart slide6).
But evidence suggests that investment funds sold significantly more securities than those that end-investors located in the euro area withdrew.
This suggests that other factors are likely to have amplified the procyclical selling by investment funds.

Increasing liquidity risk

The first is the mismatch between asset liquidity and redemption policies.
[7] As a result, fund managers sought liquidity when the capacity of markets to provide that liquidity had diminished sharply, resulting in forced asset sales and the amplification of adverse market dynamics.
Although the extent of liquidity shortfalls is likely to have varied substantially at the fund level, outflows clearly exceeded median cash holdings for all types of corporate bond funds (see right chart slide 7).

Leverage as an amplifier of market stress

[8] A recent ECB study finds that investors in leveraged funds tend to respond more strongly to deteriorating fund returns, adding to volatility in a bear market.
[9] Tentative evidence of the sharp sell-off in March corroborates the view that leverage has probably also been a source of procyclicality during the pandemic.
Investment strategies reliant on low market volatility have possibly played a significant role in this.
These volatility-targeting funds typically use leverage when market volatility is below target, as it was before the pandemic, and they have to liquidate leveraged positions when market volatility surges.
As volatility spiked and diversification benefits from cross-asset exposures vanished, volatility-targeting investors were prompted to sell assets and reduce leverage (see right chart slide 8).

Margin calls and demand for liquidity

The third factor relates to margin calls.
But they also increase liquidity risk, particularly when liquid asset holdings are inadequate.
[12] To meet margin calls, some euro area insurers and pension funds that make extensive use of interest rate swaps and foreign exchange derivatives liquidated shares held in money market funds (MMFs).
[13] There was a striking correlation between margin calls and MMF outflows over the entire period of market stress (see right chart slide9).

Systemic risks due to interdependencies

Insurance corporations, for example, not only rely heavily on MMFs for their liquidity management, they also hold over 25% of their assets in investment fund shares.
This meant that pressure on investment funds in March negatively affected insurers profitability.
[18] While some investment funds and MMFs took exceptional measures to cope with their liquidity stress, these were not sufficient to prevent systemic stress.
Some investment funds used quantity-based measures, such as the suspension of redemptions and redemption gates to address liquidity issues.
Others used price-based measures, such as swing pricing and redemption fees, to ensure trading costs were borne by redeeming investors.
Widespread suspensions may also have had adverse effects on the confidence in the wider financial sector, possibly amplifying risk-off behaviour.

The role of monetary policy in stabilising financial markets

Forceful monetary policy action, on both sides of the Atlantic, ultimately filled the void that was left by asset managers and regulators having limited liquidity management tools to curb systemic stress.
The fast rise of the non-bank sector, however, meant that traditional monetary policy tools, such as increasing the money supply to banks and accepting broader collateral, were not sufficient.
They either provide liquidity directly to non-banks that is, they expand their role as lender of last resort or they purchase large quantities of illiquid assets.
Allowing funds to become monetary policy counterparties, however, creates major operational, supervisory and regulatory challenges that cannot be solved overnight.
The announcement of the PEPP had a strong and immediate stabilising effect on financial markets.

Fixing the fault lines for non-banks

[22] Indeed, many funds started to take up liquidity risk soon after the March turmoil.
[23] Ensuring that central banks can pursue their mandates without risking financial stability requires a rethink of our current prudential framework.
It must be strengthened from a systemic risk perspective to ensure that it can be an effective first line of defence.
Without these buffers, they are unable to respond to short-notice redemptions or margin calls without engaging in forced asset sales.
We should consider giving authorities a greater ability to provide direction on the use of liquidity management policies by fund managers.
This includes a review of the liquidity requirements for MMFs and their portfolio composition, especially for LVNAV funds given their vulnerability to liquidity shocks.

Conclusion

Financing Commercial Trade 2020: The Search for Liquidity - Latest Views of the Trade Finance Market, Including Expected Reverberations of the COVID-19 Pandemic and Expectations Going Forward

Retrieved on:

Thursday, May 7, 2020

Economy, Finance, Money, Financial markets, Market liquidity, Trade finance, Credit, Banking, Asset and liability management, Liquidity crisis

Various forms of trade finance have always been available to create liquidity in both domestic and international trade in goods and services.

Key Points:

Various forms of trade finance have always been available to create liquidity in both domestic and international trade in goods and services.
This research report provides the latest views of the trade finance market, including expected reverberations of the COVID-19 pandemic and expectations going forward.
Financing Commercial Trade: The Search for Liquidity provides a direct view of the latest trends in technology and tools in the trade finance space.
Breakdowns on various forms of liquidity being used for commercial trade, including traditional methods, open accounts, and alternative financing.

The growth of non-bank finance and new monetary policy tools

Retrieved on:

Thursday, April 16, 2020

Economy, Money, Finance, Banking, Financial markets, Credit, Liquidity crisis, United States housing bubble, Market liquidity, Liquidity risk, Central bank, Bank

To address this question, we develop an asset pricing model with both bank and non-bank financial institutions.

Key Points:

To address this question, we develop an asset pricing model with both bank and non-bank financial institutions.
Non-banks are then left without a lender-of-last-resort, and central bank liquidity operations with banks are not sufficient to mitigate the crisis.
In our stylized model, opening liquidity facilities to non-banks and purchasing illiquid assets are then essential measures to tackle a liquidity crisis.

Monetary policy and non-banks

This pattern holds in particular for the US financial system, with non-bank institutions holding more than double the financial assets of traditional banks.
In Europe as well, non-banks have become an increasingly important source of financing for the real economy over the past decade (ESRB, 2019).
In particular, non-banks lack of access to central banks refinancing operations might create new obstacles in the transmission mechanism of monetary policy and for the role of lender-of-last-resort.
In fact, the existence of a large financial sector without direct access to the central bank is often considered a leading explanation for the severity of the 2008-09 crisis and the consequent expansion of monetary policy tools (Bernanke, 2009; Mehrling, 2011).
Chart 1 Evolution of the proportion of assets held by banks, non-banks and the Fed

A new model of liquidity risk and non-banks

In the model, every financial institution is in the business of performing liquidity transformation by holding assets that are less liquid than its liabilities.
In normal times, banks and non-banks efficiently minimise this liquidity risk by maintaining access to short-term money markets.
However, when the value of the assets used as collateral becomes too volatile, these cannot be pledged anymore and liquidity risk shoots up.
This higher liquidity risk leads in turn to a fall in asset prices, because financial intermediaries require a larger liquidity premium for holding risky financial assets.
In this case, the central bank may intervene and reduce liquidity risk by providing central bank reserves i.e.
The distinguishing feature of our work is that we explicitly model non-banks, which do not have direct access to central bank interventions.

What do non-banks change?

By holding central bank money, banks build up a liquid buffer.
The main finding of our paper is that, in this case, traditional monetary policy tools are not sufficient.
In this case, the connection between the central bank and non-banks is cut, and the liquidity provided by the central bank never reaches the non-bank financial sector.
Although the central bank can fully suppress the liquidity risk of traditional banks, it cannot prevent liquidity risk from growing in the non-bank sector.
If this sector is large, asset prices remain substantially depressed regardless of any significant increase in central bank money made available to banks through liquidity operations.
The key element behind this positive effect is that the central bank itself never faces any liquidity risk, as its liabilities central bank reserves are considered money.

Concluding remarks

In this regard, central bank swap agreements under which central banks lend each other currencies are crucial to provide liquidity to non-domestic institutions involved in foreign markets.
After all, in exchange for their access to central bank liquidity, banks are regulated and continuously monitored.
Central banks are thus in a good position to assess the quality of the collateral provided by banks, which may not be true of non-banks.
Moreover, the expectation of access to central bank liquidity by non-regulated agents may generate moral hazard and thus lead to additional distortions.

References

Best’s Market Segment Report: AM Best Revises Outlook on Private Mortgage Insurers to Negative as COVID-19 Hits Housing Market

Retrieved on:

Tuesday, April 7, 2020

Finance, Professional services, Residential Building & Real Estate, Construction & Property, Insurance, Economy, Finance, Money, United States housing bubble, Mortgage industry of the United States, Mortgage insurance, Mortgage loan, Liquidity crisis

AM Best has revised its market segment outlook on the private mortgage insurance segment to negative from stable, as the COVID-19 pandemic has introduced uncertainty in the viability of the primary and secondary markets for mortgages.

Key Points:

AM Best has revised its market segment outlook on the private mortgage insurance segment to negative from stable, as the COVID-19 pandemic has introduced uncertainty in the viability of the primary and secondary markets for mortgages.
However, in its new Bests Market Segment Report, Market Segment Outlook: US Private Mortgage Insurers, AM Best notes that the COVID-19 pandemic has progressed from a health crisis to a liquidity crisis, and may turn into a solvency crisis for the balance sheets of individuals and corporations alike.
This could have serious consequences for private mortgage insurers, given that their business and the fortunes of the U.S. economy are inexorably linked.
Mortgage market industry participants are hopeful for a comprehensive solution to avert such a risk to the mortgage distribution pipeline.

Private Equity Liquidity Hit by 10% VaR Caused by Coronavirus Crisis

Retrieved on:

Thursday, April 2, 2020

Economy, Finance, Money, Financial markets, Market liquidity, Private equity, Asset and liability management, Liquidity crisis

By studying previous crash scenarios and comparing to the impact of the current crisis, CEPRES experts are now applying a 10% VaR liquidity forecast to their simulations for the 2020 and 2021 projections.

Key Points:

By studying previous crash scenarios and comparing to the impact of the current crisis, CEPRES experts are now applying a 10% VaR liquidity forecast to their simulations for the 2020 and 2021 projections.
Further details of model assumptions:
The current shutdown will impact private equity, private real estate, private debt funds, infrastructure and direct investments.
In order to avoid liquidity shortfalls, we recommend now to make liquidity decisions based on a 10% VaR scenario."
CEPRES began in 2001 as the Center of Private Equity Research and was the first to 'look-through' private market funds to underlying deal and asset performance.

Liquidity Asset Liability Management Solutions Global Market (2017 to 2027) - Drivers, Restraints, Threats and Opportunities - ResearchAndMarkets.com

Retrieved on:

Tuesday, February 25, 2020

Professional services, Consulting, Economy, Finance, Money, Financial markets, Banking, Liability, Asset and liability management, Asset management, Insurance, Market liquidity, Liquidity crisis

This study takes a systematic approach to studying and analyzing the historical data and growth developments in the future of the liquidity asset liability management solutions market.

Key Points:

This study takes a systematic approach to studying and analyzing the historical data and growth developments in the future of the liquidity asset liability management solutions market.
The study will help readers understand the competitive analysis of the liquidity asset liability management solutions market, and gauge the future trajectory of progression.
Are there any specific strategies that companies in the liquidity asset liability management solutions market are adopting to stay ahead?
What are the factors that are expected to support the evolution of the liquidity asset liability management solutions market?

Outlook on the Global Liquidity Asset Liability Management Solutions Market to 2027 - Finastra, Fiserv, Infosys Limited and Oracle Among Others

Retrieved on:

Friday, February 21, 2020

Economy, Finance, Money, Financial markets, Banking, Liability, Asset and liability management, Asset management, Insurance, Market liquidity, Liquidity crisis

This study takes a systematic approach to studying and analyzing the historical data and growth developments in the future of the liquidity asset liability management solutions market.

Key Points:

This study takes a systematic approach to studying and analyzing the historical data and growth developments in the future of the liquidity asset liability management solutions market.
The study will help readers understand the competitive analysis of the liquidity asset liability management solutions market, and gauge the future trajectory of progression.
Are there any specific strategies that companies in the liquidity asset liability management solutions market are adopting to stay ahead?
What are the factors that are expected to support the evolution of the liquidity asset liability management solutions market?

Liquidity Asset Liability Management Solutions Market - Global Industry Analysis, Size, Share, Growth, Trends, and Forecast, 2019 - 2027

Retrieved on:

Tuesday, September 24, 2019

Economy, Finance, Money, Banking, Financial markets, Asset and liability management, Asset management, Insurance, Liability, Market liquidity, Liquidity crisis, CAMELS rating system

The study will help readers understand the competitive analysis of the liquidity asset liability management solutions market, and gauge the future trajectory of progression.

Key Points:

The study will help readers understand the competitive analysis of the liquidity asset liability management solutions market, and gauge the future trajectory of progression.
This report includes an in-depth analysis of the various competitors in the liquidity asset liability management solutions market, their product portfolios, revenues, and key developments.
This studyon the liquidity asset liability management solutions market categorizes the information into three segments: component, institution, and region.
Are there any specific strategies that companies in the liquidity asset liability management solutions market are adopting to stay ahead?