16 April 2012

ICFR: Non-financial corporates - Disintermediation & non-bank funding

The International Centre for Financial Regulation reports that the more regulatory pressure compresses the traditional banking sector's ability to provide credit, the more important are other sources of financial intermediation if economic recovery is to be supported.

However, as regulators expand the perimeter of regulation in a bid to curb the so-called shadow banking sector, the more alternatives to bank intermediation are being restricted too. In this context it is extremely important for policy-makers to distinguish between measures to limit systemic risk arising from the interconnectedness of financial intermediaries with the banks from other channels of financial intermediation. These may not only be essential for the economy but may even underpin financial stability by helping to promote a more diversified financial system, less “super-dependent” on bank (credit) intermediation.

Flow of funds data for the eurozone indicate that in the wake of the financial crisis the non-financial sector, as might be expected, sharply cut back its external financial dependency. The composition of this funding has however changed markedly, with recourse to loans, which almost fully accounted for all external financing prior to the crisis, being eliminated. Indeed, in the aggregate, the non–financial sector is now a net lender.

Notably, there has been a substantial rise in the issuance of corporate bonds. This has been the case both in the eurozone and the UK as well as in the US, where the use of the corporate bond market as a source of funding is much more developed. Yields in the debt markets have been depressed in the first quarter with both the cautious economic outlook and central banks’ ample provision of liquidity being key factors. Moreover, doubt about the riskiness of sovereign bonds and concern over what constitutes safe assets have enhanced the attractions of good quality corporate debt.

Should the traditional banking sector continue to be beset by funding problems, the difficulty of providing credit to the private sector will become more acute. All the more reason then for policy-makers to explore the potential benefits that may accrue from seeking out alternatives to bank intermediation. Less dependence on bank credit and a more diversified financial system may ultimately be more sustainable and better for financial stability.

Author Richard Reid says that perhaps we should be wary of the often wide-ranging use of the term ‘shadow banking’. Alternative channels of financial intermediation may prove vital for the real economy. Now might be an opportunity to explore some key questions about the future structure of the financial system. The experience of recent years suggests a need to adopt a longer-term perspective if we want sustainable regulation for sustainable intermediation.

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