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Shadow Maturity Transformation and
Systemic Risk
Sandra Krieger
Executive Vice President and Chief Risk Officer, Federal Reserve Bank of New York
8 March 2011

Overview of discussion
 What is shadow bank maturity transformation and why do we care
about this?
 What role did this play leading up to and during the recent financial
crisis?
 How will financial reform affect the shadow banking system?
 What more needs to be done?

2

What is credit intermediation?

Maturity transformation: fund
long-term assets with short-term
liabilities
Credit transformation:
enhancement through use of
priority or guarantees
Liquidity transformation: illiquid
assets funded by liquid liabilities

3

Topology of Credit Intermediation

explicit and direct
Credit put

Official
sector

Liquidity put

4

Topology of Credit Intermediation

implicit
and
indirect

Credit put Liquidity put

explicit and direct
Credit put
Liquidity put

explicit
and
indirect

Credit put Liquidity put

implicit and direct
Official
sector

Credit put
Liquidity put

unenhanced

5

Shadow Maturity Transformation

Banksponsored
MMMF

implicit
and
indirect

Tri-Party
Repo

ARS

Credit put Liquidity put

explicit and direct
Credit put
Liquidity put

explicit
and
indirect

Banksponsored
SIV

Credit put Liquidity put

ABCP

implicit and direct
Official
sector

Credit put

GSE
Liquidity put

unenhanced

VRDO

Independent
MMMF

Independent
SIV

6

Shadow Banking Sector
$25,000,000

$15,000,000

$10,000,000

$5,000,000

$1985Q4
1986Q3
1987Q2
1988Q1
1988Q4
1989Q3
1990Q2
1991Q1
1991Q4
1992Q3
1993Q2
1994Q1
1994Q4
1995Q3
1996Q2
1997Q1
1997Q4
1998Q3
1999Q2
2000Q1
2000Q4
2001Q3
2002Q2
2003Q1
2003Q4
2004Q3
2005Q2
2006Q1
2006Q4
2007Q3
2008Q2
2009Q1
2009Q4
2010Q3

($ millions)

$20,000,000

Shadow Maturity Transformation

CP, Repo and Securities
Lending, Money funds

Shadow Credit Transformation

ABS, GSE debt, Agency
MBS

Bank Liabilities

7

Official Sector Support for Shadow Banking Activities
FR releases
“Stress Test“
results

1,000

TALF
announced

JPMC
acquisition;
PDCF/TSLF

TAF
Established

1,200

Lehman
Bankruptcy
/AIG Lending

September 2007 to March 3, 2011

Credit & Liquidity Programs1

AMLF

TSLF

TALF

CPFF

PDCF

TAF

($ billions)

800

600

400

200

Mar-11

Feb-11

Jan-11

Dec-10

Nov-10

Sep-10

Aug-10

Jul-10

Jun-10

May-10

Apr-10

Mar-10

Jan-10

Dec-09

Nov-09

Oct-09

Sep-09

Aug-09

Jul-09

May-09

Apr-09

Mar-09

Feb-09

Jan-09

Dec-08

Oct-08

Sep-08

Aug-08

Jul-08

Jun-08

May-08

Apr-08

Feb-08

Jan-08

Dec-07

Nov-07

Oct-07

Sep-07

0

Source: March 3, 2011 H.4.1 release. Differences in balances compared to other material in this presentation may be due to differences in timing or metrics
1. AMLF - Asset-Backed Commercial Paper Money Market Fund (ABCP MMMF) Liquidity Facility; TSLF- Term Securities Lending Facility; TALF - Term AssetBacked Securities Loan Facility; CPFF -Commercial Paper Funding Facility; PDCF- Primary Dealer Credit Facility; and TAF - Term Auction Facility.
2. Assets of the portfolio are exhibited and not the loans.

8

Asset-backed commercial paper market (ABCP)
$2,500,000.00

($ millions)

$2,000,000.00

$1,500,000.00

$1,000,000.00

$500,000.00

$Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
ABCP

Financial CP

Nonfinancial CP

9

Tri party Repo
$3,500,000

$10,000,000.00
$9,000,000.00

$3,000,000

$8,000,000.00
$7,000,000.00
$6,000,000.00

$2,000,000

$5,000,000.00
$1,500,000

($ millions)

($ millions)

$2,500,000

$4,000,000.00
$3,000,000.00

$1,000,000

$2,000,000.00
$500,000
$1,000,000.00
$0

$-

Overnight Repo

Financial CP

M2

10

($ billions)

($ billions)

Money Market Mutual Funds

11

ABCP: Current regulatory changes
 FAS 166/167 and Basel capital rules may significantly increase
liquidity and capital requirements for bank backup lines of credit for
conduits
 Balance sheet consolidation for loans or securities of the conduit
 increased risk-based leverage ratio and capital requirements as well
higher loan loss reserves

 Proposed liquidity requirements for banks could make backup lines
more expensive
 liquid assets must be sufficient to meet its stress liquidity needs for a 30day time horizon

12

The Future for ABCP
The cumulative impact of these changes will likely include:
 More required capital and liquidity for bank-sponsored conduits,
corresponding to higher-cost lines of credit to finance companies
 Likely end of programs which exist solely for off-balance sheet capital
arbitrage
Mitigating behavior by the industry might include:
 Shift in conduit sponsorship from US banks to non-banks or foreign banks
with balance sheet capacity
 Re-structuring of conduits in order to avoid accounting consolidation (e.g. sale
of first-loss tranche to transfer control to third-party)


The ABCP market will be smaller and more expensive, sponsored by nonbanks and largely fund asset-backed loans originated by non- bank finance
companies

13

Tri Party Repo Market: Current Regulator-Driven Changes




Industry Tri-Party Task Force has suggested improvements in the following
areas
 Operational Arrangements
 Dealer Liquidity Risk Management
 Margining Practices
 Contingency Planning
 Transparency
“Tri-Party Repo Infrastructure Reform” White Paper by FRBNY
 Market reliance on intra-day credit from clearing banks
 Aggressive dealer liquidity management
 Cash investor and clearing bank risk management
 Cash contingency plans around large dealer default
Taskforce Website:
http://www.newyorkfed.org/banking/tpr_infr_reform.html

14

The Future for Tri-Party Repo




Impact on the market
 Reduced intra-day credit and daily unwind
 Higher margins, less cyclical margins, higher-quality collateral
Future of broker-dealer model
 Broker-dealer model now has liquidity backstop, but will be subject to
leverage requirements and prudential supervision instead of voluntary
oversight
 Need tri-party solution to failure of major borrower to reduce systemic risk

15

MMMF Buffers
Investor “run” event

Ex ante buffers

Ex post buffers

time
Ex ante buffers are costly but
allow preservation of stable NAV

Absorbing losses when they
occur is less costly but is not
consistent with stable NAV

Preferred option if investors care
more about liquidity

Preferred option if investors
care more about yield

Example:
Capital, liquidity, risk standards

Examples:
variable NAV or “hold back”

Loss absorption buffers address the risk of “credit” losses but may not
adequately reduce the risk of losses associated with sales of assets at
fire sale prices
Access to a source of non-official emergency liquidity could further
reduce this risk
16

Conclusions


The motivations for shadow banking have become even stronger with increases in
capital and liquidity requirements on traditional institutions;



The objective is to reduce the risks associated with maturity transformation through
more appropriate, properly priced and transparent backstops – credit and liquidity
“puts”.



Regulation has done some good, but more work needs to be done to prevent shadow
credit intermediation from being a continued source of systemic concern.

17