By Greg Medcraft, Director of the OECD Directorate for Financial and Enterprise Affairs
With the COVID-19 pandemic putting enormous strain on financial markets, a new OECD report on structural developments in global financial intermediation shows how the structure of markets has changed since the last crisis and where new fragilities lie.
The global financial crisis of 2008 underlined the importance for policy makers in understanding the scale and types of financial intermediation in their economies. During the financial crisis, non-bank financial intermediation was of particular concern to authorities as such forms of ‘shadow banking’ contributed to both the root causes of the crisis, the transmission of financial contagion, and the amplification of shocks.
As this report is published, the rapid spread of the novel coronavirus Covid-19 has caused a global health crisis, has brought economic activity in some sectors to a halt, and has presented the greatest challenge to the global financial system since 2008. As then, understanding financial intermediation activities is critical to mapping the faultlines in the global financial system and mounting effective policy responses.
However, the shape of financial intermediation has changed in important ways since the global financial crisis. Activities in non-bank intermediation, including market-based intermediaries like investment funds and securitised products, have grown and are increasingly interconnected with financial markets. Understanding the interplay between these elements, and the benefits and risks of each, offers a more complete understanding of how global finance can contribute to sustainable economic growth. It also helps provide the full picture needed to help policy makers prepare for and respond to shocks, including pandemics.
“Structural developments in global financial intermediation – The rise of debt and non-bank credit intermediation” shines a light on the evolution of global financial intermediation in three key ways:
- It maps the broad-based growth of financial intermediation relative to GDP in many advanced and emerging market economies, and with this growth a shift toward market-based finance.
- It assesses the shift from equity to debt markets, and the growing imbalances in sovereign and corporate debt markets during a period of highly accommodative monetary policies.
- It draws attention to key activities in credit intermediation that could contribute to structural vulnerabilities in the global financial system, including: a sharp rise of below-investment grade corporate debt, in particular leverage loans and collateralised loan obligations; the growth of open-ended investment funds that purchase high-yield debt and leveraged loans; and risks associated with the large stock of bank contingent convertible debt.
While these various activities have helped to satisfy investors’ reach for yield during years of market exuberance, they represent new potential faultlines of systemic risk in the event of exogenous shocks, be they from trade tensions, geopolitical risks or the current global pandemic. This report underlines the need for policy frameworks to adapt to market-based finance, and fully reflect the interaction between monetary, prudential, and regulatory tools on credit intermediation. It also underlines the need for dynamic microprudential and activities-based tools to help mitigate excessive risk taking with respect to liquidity and leverage.
By mapping the global financial system, evaluating growing imbalances and risks that could amplify shocks, and assessing the interaction between macro and regulatory tools, this report provides a practical complement to the OECD’s Policy Framework for Effective and Efficient Financial Regulation. Financial authorities should use this analysis to inform both their assessments of activities and risks, and efforts to maximise available tools to harness the benefits of market-based finance to support fair, efficient markets and sustainable economic growth.