Back in the day, financial intermediation was a pretty simple equation – individuals put their long-term savings into bank accounts, insurance, or investments. In turn, banks, insurers and asset managers invested that money in nice tidy long-term instruments like equities, bonds and asset-backed securities.
Not so today according to a recent paper from the International Monetary Fund that is raising alarm bells about the growing role of asset managers – including ETFs – as a major source of funding for banks through the shadow banking system. In their paper, The Non-Bank-Bank Nexus and the Shadow Banking System authors Zoltan Pozsar and Manmohan Singh argue that asset managers are now a dominant source of demand for non-M2 types of money. In fact, they act as “collateral mines” for the growing shadow banking system.
Regulators need to understand and account for the money demand side of the asset management business especially because it is the place where long-term savings are turned into short-term savings: maturity transformation that is a result of changes in portfolio management, portfolio allocation decisions and securities lending.
The authors call this reverse maturity transformation – plan sponsors might call this, more simply, mismatch risk. Except that the paper shows it’s happening on a huge scale, with ETFs and other asset managers part of a long and tangled collateral chain worth trillions.
It’s an interesting take on the ultimate power of the shadow banking system – what’s worrying is that regulators haven’t really factored this into the way they approach financial markets.
As the asset management industry grows, propelled at least in part by ETF assets, this collateral mine is going to become a lot deeper and a lot darker unless regulators redefine their model of how financial systems work.