Federal Reserve Board ("FRB") Vice Chair for Supervision and Financial Stability Board ("FSB") Chair Randal Quarles described vulnerabilities of nonbank financial intermediation ("NBFI"), revealed by COVID-19 related shocks to the financial markets.
In his speech at the SIFMA annual conference, Mr. Quarles stated that there has been substantial growth in NBFI resulting from the increased use of U.S. dollar funding by nonbank institutions, such as insurers, pension funds and central counterparties (or "CCPs"). These institutions lack access to funding backstops "in times of stress." Mr. Quarles explained that approximately 50 percent of total global financial intermediation is made up of NBFI, citing the Financial Stability Board's Annual NBFI Global Monitoring Report.
Mr. Quarles asserted that the outbreak of the pandemic and subsequent efforts to contain it, including quarantines, lockdowns and social distancing, resulted in "the deepest and broadest global recession since the Great Depression." Mr. Quarles identified the following factors, among others, relating to nonbank entities that exacerbated the destabilization of the financial markets:
- the "dash" by businesses for liquidity in U.S. dollars, which resulted in the failure of traditional sources of cash to handle the demand and the overwhelming of dealers;
- the sale, by institutional investors, of large volumes of longer-term government bonds for cash, which decoupled the relativity of government bonds prices to futures prices;
- increased margin calls that were the result of widespread sales of securities; and
- a significant decline in asset prices, which potentially inhibited investors from purchasing undervalued assets in a countercyclical manner, resulting from the steep reduction in market liquidity.
Mr. Quarles credited the public sector with taking decisive action based on lessons from the 2007-08 recession. He highlighted the efforts of central banks in expanding their asset purchases and implementing liquidity support through liquidity facilities for nonbank entities. Additionally, Mr. Quarles pointed to the Federal Reserve's establishment of swap lines with central banks across the world in order to facilitate international trade.
In underscoring the success of central bank actions in alleviating market strains caused by the pandemic, Mr. Quarles emphasized the fragility of the nonbank system. Mr. Quarles stated that the FSB is working to "map the current financial system, including the bank and NBFI sectors," in order to identify the sources and pathways of risk transmission that have been revealed as a result of the pandemic.
- FRB Speech, Randal K. Quarles: The Financial Stability Board's Roadmap for Addressing NBFI Vulnerabilities
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