Federal Reserve Bank of New York Staff Reports: Shadow Banking ppt

This paper presents preliminary ndings and is being distributed to economists and other interested readers solely to stimulate discussion and elicit comments. The views expressed in this paper are those of the authors and are not necessar- ily reective of views at the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors. Federal Reserve Bank of New York Staff Reports Staff Report No. 458 July 2010 Revised February 2012 Zoltan Pozsar Tobias Adrian Adam Ashcraft Hayley Boesky Shadow Banking REPORTS FRBNY Staff Adrian, Ashcraft: Federal Reserve Bank of New York. Pozsar: International Monetary Fund. Boesky: Bank of America Merrill Lynch. Address correspondence to Tobias Adrian (e-mail: tobias.adrian@ny.frb.org). The views expressed in this paper are those of the authors and do not necessarily reect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Abstract The rapid growth of the market-based nancial system since the mid-1980s changed the nature of nancial intermediation. Within the market-based nancial system, “shadow banks” have served a critical role. Shadow banks are nancial intermediaries that con- duct maturity, credit, and liquidity transformation without explicit access to central bank liquidity or public sector credit guarantees. Examples of shadow banks include nance companies, asset-backed commercial paper (ABCP) conduits, structured investment vehicles (SIVs), credit hedge funds, money market mutual funds, securities lenders, limited-purpose nance companies (LPFCs), and the government-sponsored enterprises (GSEs). Our paper documents the institutional features of shadow banks, discusses their economic roles, and analyzes their relation to the traditional banking system. Our de- scription and taxonomy of shadow bank entities and shadow bank activities are accom- panied by “shadow banking maps” that schematically represent the funding ows of the shadow banking system. Key words: shadow banking, nancial intermediation Shadow Banking Zoltan Pozsar, Tobias Adrian, Adam Ashcraft, and Hayley Boesky Federal Reserve Bank of New York Staff Reports, no. 458 July 2010: revised February 2012 JEL classication: G20, G28, G01 ` The Federal Reserve Bank of New York, November, 2009 Short-Term Funding Short- to Lon g-Term C ash MMDAs Households, Businesses, Governments CDs Equity Funding Long-Term Investments Equity Equity ` Equity Short-Term Debt Instruments Regulated Money Market Unregulated Money Market Agency MBS Agency Discount Notes Intermediaries Intermediaries *Conforming mortgages RRs Other* Liquidity Puts A1 *ARS, MMMFs A1 CP AAA ABCP AA-BBB BDP Equity RRs *Conforming student loans 2a-7 MMMFs Other* A1 *ARS, MMMFs, as well as A1 A1 (AAA) ABS Tranches CP MTNs and t erm ABS CP A1 ABCP ABCP AAA BDP BDP AA-BBB RRs RRs Short-Term Savings Equity Other* Other* *Conforming SBA loa ns *TOBs and VRDOs A1 *ARS, MMMFs Money Market Portfolios CP ABCP BDP RRs Other* A1 AAA Offshore (non-2a-7) MMMFs *ARS, MMMFs, as well as A1 AAA AA-BBB A1 MTNs and term A BS CP ABCP AA-BBB LTD MTNs CP ABCP Equity Repo Equity Supers CNs* ABCP BDP LTD Haircuts BDP RRs Households Equity O/C High-Yield CLOs RRs Ultra-Short Bond Funds Other* Households and Nonprofits (LBO Loans) Other* A1 *MMMFs A1 *TOBs and VRDOs CP AAA ABCP AA-BBB BDP 2nd Lien Equity RRs Equity O/C O/C O/C Other* CP *FHC affili ate Consumer ABS *ARS, MMMFs, as well as A1 ABCP (Credit Card ABS) MTNs and te rm ABS CP BDP A1 ABCP AAA BDP AA-BBB RRs Equity O/C Equity Other* Nonfinancial Corporates O/C *ARS, MMMFs an Banks DW AAA TAF AA-BBB FX Swaps LTD MTNs Tri-Party Repo System TSLF Supers CNs* Feder al, State TSLF Nonfinancial Businesses Equity Tri-Party Clearing Banks* and Local Governments PDCF CPFF TALF AMLF MMIFF ML, LLC Equity O/C O/C an Banks ML II, LLC *BoNY and JP Morgan Cha se ML III, LLC LSAPs RoW O/C Equity (Foreign Central Banks) Equity RMBS (1st lien, private label) MTNs Cash Reinvestment Accounts CP A1 A1 ABCP AAA CP BDP AA-BBB ABCP Equity BDP RoW Governments RRs (Sovereign Wealth Funds) Equity O/C Subprime ABS Other* *Done by cust odian banks (2nd lie n, subprime, HELO Cs) Trading Book *MMMFs, MT Ns, term ABS and on an agent bas is. A1 TOBs and VRDOs AAA AA-BBB Equity Haircuts Cash Reinvestment Accounts *Issued to central banks CMBS and High-Yield CLOs A1 in exchange for investibe FX (LBO Loans) CP Long-Term Savings A1 ABCP AAA BDP F ixed Income Portfolios* AA-BBB RRs MTNs Equity Equity Other* *Done by real money accounts *MMMFs, MT Ns, term ABS and on a principa l basis. TOBs and VRDOs CNs *Bank, Shadow Bank and Corporate Debt Consumer ABS (Card, Aut o, Student Loa n) CP A1 AAA Cash AA-BBB MTNs Equity LTD Equity Por tfolios* Haircuts Equity Equity O/C Other ABS (Floorplan, Equipment, Fleets) A1 AAA *Mutual Funds, ETFs, Separate Accounts AAA AA-BBB *Bank a nd Corporate Debt AA-BBB MTNs Equity CNs* O/C CP Middle-Market CLOs ABCP (Loans to SME s) Cash LTD AA-BBB Equity Equity Equity Equity *Term ABS and CDO debt and equity tranches Public Equity Cash MTNs LTD Structured Credit Equity Equity *Hedge Funds and Private Equity (only credit exposures) Maiden Lan e LLC 3/11/08 and 3/16/08, respectively Portfolio Pr otection* Equity Households, Businesses, Governments Households, Businesses, Governments Equity and the Rest of the Wor ld (RoW) Equity AA-BBB Equity Equity Source: Shadow Banking (Pozsar, Adrian, Ashcraft, Boesky (2010)) Commercial Bank* Step (7): Wholesale Fundi ng (Shadow Ba nk "Depositors" ) ABS Reserves Warehouse He dges Long-Term Synthetic Liabilities Broker-dealer CVA desks, ABS pipeline hedges, Counterparty Hedges Warehouse He dges Equity Conceptualized, designed and created by Zoltan Pozsar (zoltan.pozsar@ny.frb.org ) Debt Insu- rance TLGP Wholesale Funding (Term Debt Funding) *Funded by UST's $50 billion No Explicit Fees GSEs, DoE, SBA Federal Government Agency Debt Purchases Agency MBS Purchases Insurance Guarantees Step (4): ABS Warehous ing Finance Company* The "Synthetic" Shadow Banking System Broker-Dealers* Funded Synthetic CDOs* Consumers Finance Company* Fannie and Freddie* Credit Hedge Funds (Credit-Linked Notes) Unfunded Synthetic CDOs* Single-Name and Index CDS Indices Single-Name and Index Assets Bond(s) Sovereign CDS Protection Boug ht Protection Sold Agency Debt Purchases Proprietary trading desks, credit hedge funds, etc. Term Savings Commercial Banks AA-BBB Synthetic Exposures* Counterparty Risks* Credit Bets Term Savings Hedgers* Deposits Bank Equity Real Money Accounts* Equity Por tfolios Money Market "Portfolios" Loans The Traditional Banking System ("Originate-to-Hold-to-Maturity-and-Fund-with-Deposits") unfunded liabilities, etc. Loa ns, ABS and CDOs Unfund ed Protection Referencing ABS and single-name CDS *Referencing single-name CDS indices, etc. *Inability to meet Treasurys CDS AAA AAA AAA […] Equity Loan(s) Structured Credit and Loan negative basis traders, real money accounts, etc. Speculators* Unfund ed Protection Protection Sold *Marke t Makers Funded Protection "Naked" Positions Funded Protection Counterparty Hedges Hedges Funded Protection *Referencing corporate loan indices, etc. *Hedging Motiv es Insured Assets *Speculative Motives indices, etc. Ultimate Creditors Bond(s) CDS Unfund ed Protection Protection Sold […] CDS Counterparty Hedges Funded Protection Ultimate Borrowers Corporate CDS CDPCs CPDOs* Short-Term Synthetic Liabilities Warehouse He dges Synthetic Credit Liabilities Private Risk Repositories The "Synthetic" Shadow Banking System (Derivatives-Based Risk Repositories) Warehouse He dges Loa ns, ABS and CDOs Counterparty Hedges Warehouse He dges Warehouse a nd Counterparty Hedges AAA Loa ns, ABS and CDOs 9/19/2008 10/21/2008 11/10/2008 Subprim e ABS Reserves ABCP RMBS 10/7/2008 11/25/2008 3/24/2008 10/11/2008 12/12/2007 12/12/2007 Tri-Party Collatera l Reserves ABCP Reserves Non- repo MM instru me nts Reserves $ FX CP Reserves AAA Reserves Warehou sed ABS Reserves CDS on CDOs Reserves CPFF TALF Maide n Lane III LLC TAF FX Swaps TSLF/PDCF Equity Equity Private Credit Transf ormation (Tail Risk Absorption) Provision of Risk Capital Private Risk Repositories *Unaffiliated with originators! Credit Insurance (Mortgag e Insurers) Credit Hedges Premia Credit Insurance Premia Credit Insuranc e Premia Credit Insurance (Par Puts) Client Funds Credit "References" Mortgage Insurers* Monoline Insurers* *Unaffiliated with originators! *Unaffiliated with originators! MTNs Equity Tranches Mezz ABS Super Senior Credit Insurance (AIG FP) Credit Insurance (AIG FP) […] MTNs LTD Loans AAA (A4) *Public and Private Pension Funds, Debt Tranches Pension Funds, Insurance Companies* Structured Credit Portfolios* Term Savings HG ABS Super Senior Structured Credit Credit Insurance (Monolines) A4 and AA-BBB ABS Tranches AAA Diversified Insurance Co. LPFCs Client Funds Long-Term Debt Alternative Asset Managers* Pension Liabilities Captive Finance Company *Capital Notes Loans AA-BBB REITs BDP MTN *Independent c onduit Industrial Loan Company* A1 Loans ABCP Loans CP LTD The "External" Shadow Banking System (DBDs: Originate-to-Distribute Model | Independent Specialists: Originate-to-Fund Model) Repos Off-Balance Sheet Equity Liquidity Puts* A2 & A3 (AAA) ABS Tranches Public Equity Term Savings ABS Agency LTD Structured Credit Long-Term nstruments (LTD) Cash Collater al ABCP Loans ABCP MTNs Loans Private LTD AA-BBB *Broker-dealer affiliate *ARSs, TOBs, VRDOs *Medium-term debt Independent Specialists' Credit Intermediation Process Standalone Finance Company Credit Hedge Fund Loans Loans *Finance company affiliate […] Term Savings LTDs Cash Collater al Securities Lending* Agency Debt* Wholesale Funding (Medium-Term Funding) Securities Lent Loans AAA (A2-A3) Cash Collater al Loans Long- Term Munis Short- Term Munis Loans Agency Debt ABS Industrial Loan Company* AAA Local Governments Loans Brokere d Deposits AA-BBB Tax Revenues Muni Bonds Brokere d Deposits Brokerage Clients' Cash Balances FX Reserves Bonds* Mezzanine CDOs Super Seniors Principal Securities Lending BBB Supers *Broker-dealer affiliate Savings: Export Revenue "Equity" Tax Revenues State Bonds *Broker-dealer affiliate AA-BBB Loans AA-BBB Repos Equity Tax Revenues Bonds State Governments AAA Prime Broker Super Seniors Repos Loans *Broker-dealer affiliate AAA Securities Lent AA-BBB ABS High-Grade CDOs Asset Manager, Off-Balance Sheet Securities Lending* Supers Private MTNs Cash Collater al Loans ABCP Federal Government Tax Revenues Treasury Bonds Credit Hedge Fund* Broker-Dealer* Loans Repos MTNs OMO Collatera l Savings: FX Reserves Local Currency Single-Seller Conduit DBDs' Credit Intermediation Process Medium-Term Instruments Agent Securities Lending Loans AA-A Private Equity Euro Deposits Portfolio Com panies Firms ABCP LBO Loans *European ba nk affiliat ed AAA ABCP Arbitrage Conduit Assets Loans Businesses Reverse Repos CRE CRE Loans Loans Bonds Europe AA-BBB Businesses Europe Savings: Excess Cash "Equity" Federal Reserve Invest- ments C&I Loans […] Euro Deposits Reserves Savings: Excess Cash "Equity" Wholesale Funding (Overni ght Funding) Mezz ABS Mezz CDO ABS Collateral European Banks' Shadow Banking Activites Cash lendi ng for securities collateral Mezz CDO The "Internal" Shadow Banking System (Private Originate-to-Distribute Model) CP ABCP *FHC affili ate *ARSs, TOBs, VRDOs Multi-Seller Conduit* Goods & Services Loans Loans AA-BBB ABCP Loans MTNs Sweep Accounts Long- Term Munis Loans ABCP Equity Liquidity Puts* Off-Balance Sheet AA-BBB Loans Structuring and Syndication Loans Reverse Repos* ABCP Equity AAA Savings: Excess Cash BBB Supers AAA *BHC affili ate "Equity" ABS $1 NAV Shares BDPs BDPs Assets Loans *FHC affili ate ABCP Home 1st Lien Subprime Homeowners $1 NAV Shares AA-BBB Loans CP $1 NAV Shares $1 NAV Shares High-Grade CDOs AA-A Supers *Capital Notes $1 NAV Shares SIV, SIV-Lite Off-Balance Sheet Home 1st Lien Loans Dollar Deposits Loans Securities $1 NAV Shares Direct Investmen Short- Term Savings FHCs' Credit Intermediation Process $1 NAV Shares Repos CP Loans ABCP AA-BBB $1 NAV Shares (Retained Portfolios) Off-Balance Sheet Loans* Agency MBS Discount Notes Loans A1 Private ABS Agency Debt Munis ARSs TOBs or VRDOs FFELP ABS Private ABS Agency Debt (Retained Portfolios) CP ABS FH LBs Fannie and Freddie Cash "Plus" Funds Agency Bills The Government-Sponsored Shadow Banking System (Public Originate-to-Distribute Model) Enhanced Cash Funds $1 NAV Shares Ultimate Borrowers CMOs Direct Money Market Investors Ultimate Creditors Loans* Agency Pass- Through s Agency MBS CMO Tranches Corporate Treasurers A1 Off -Balance Sheet ABS Intermediatio n On-Balance Sheet ABS Intermediatio n The GSEs' Credit Intermediation Process FHLBs (Time-Tranched Agency MBS) Federal Government Off-Balance Sheet Agency MBS Discount Notes MMMF Insuranc e The "Cash" Shadow Banking System Deposit Insurance (FDIC) Liability Insurance (Federal Government) Credit Insurance (GSEs, DoE, SBA) Liability Insurance (Federal Government) Liability Insurance (EU Gov ernment) Insuranc e Premia Deposit Insuranc e FDIC No Explicit Fees No Explicit Fees Implicit Insuranc e Federal Government 11/25/2008 Agency MBS Reserves Deposit Insurance (FDIC) Public Risk Repositories (Tail Risk Absorption) Public Risk Repositories Public Credit Transformation (Tail Risk Absorption) European Sovereign and Quasi-Sovereign States Bank Equity 11/25/2008 Temporary PBGC Pension Funds Client Funds Dollar Deposits Equity Funding Agency Debt Reserves Discount Window Loan Collateral Agency Debt Reserves Term Savings Traditional Banks' Lending Process Asset Managers* Bank Treasurers Bank Equity Loans Bank Equity LGIPs Loans Exchange Stabilization Fund $1 NAV Shares Insuranc e Premia *Asset Ma nagers, Insurance Compa nies and ABS Implicit Insuranc e 9/18/2008 MMMF Guarantee Households, Businesses Checking Account and the Rest of the World The Traditional Banking System CDs Ultimate Creditors Depositors Deposits Equity Step (1): Loan Origina tion TBA Market Step (3): ABS Issuance Short- Term Savings Ultimate Borrowers Reserves 11/25/2008 No Explicit Fees Implicit Insuranc e Debt Funding (Short and Long-T erm Deposits Implicit Insuranc e Assets Borrowers Loans Asset Manager* AAA Loans Checking Accounts Wholesale Funding (Short-Term Fund ing) AA-BBB Arbitrage Conduit No Explicit Fees Implicit Insuranc e SBA ABS (ABS Ware house Conduits) Structuring and Syndication Single-Seller Conduit (Warehouse and Term) SIV Loans ABCP (Warehouse and Term) Loans Loans Discount Notes Step (2): Loan Warehousi ng Agency Debt Equity Step (5): ABS CDO Issuance Loans* *Capital Notes Off-Balance Sheet ABCP Mezzanine CDOs Off-Balance Sheet AA-BBB Short- Term Munis Loans Brokere d Deposits AAA and Life and P&C Insurance Companies CDOs Subprime, RMBS, CMBS […] Mezz ABS Hybrid Conduits *FHC affiliated Maiden Lan e II LLC MMIFF AMLF Trading Books Catalogue: , Shadow Bank Liabilities Step (6): ABS "Intermediation" Trading Books Repo Conduits ABCP Off-Balance Sheet Loans Bonds Assets "Prime" Homeowners *DBD affiliate Loans Single-Seller Conduit Multi-Seller Conduit* Broker-Dealer* Multi-Seller Conduit* The Shadow Banking System Loans Bonds ("Rent-a-Conduit") Broker Sweep Accounts Single-Seller Conduit ABS and CDO Equity Loans ABS Loans ABS Equity Hybrid Conduits ABCP CP 1 1. Introduction Shadow banks intermediate credit through a wide range of securitization and secured funding techniques such as asset-backed commercial paper (ABCP), asset-backed securities (ABS), collateralized debt obligations (CDOs) and repurchase agreements (repos). These securities are used by specialized shadow bank intermediaries that are bound together along an intermediation chain. We refer to the network of shadow banks in this intermediation chain as the shadow banking system. While we believe that shadow banking is a somewhat pejorative name for such a large and important part of the financial system, we adopt it in this paper. Over the past decade, the shadow banking system provided sources of funding for credit by converting opaque, risky, long-term assets into money-like, short-term liabilities. Arguably, maturity and credit transformation in the shadow banking system contributed to the asset price appreciation in residential and commercial real estate markets prior to the 2007-09 financial crisis. During the financial crisis, the shadow banking system became severely strained and many parts of the system collapsed. Credit creation through maturity, credit, and liquidity transformation can significantly reduce the cost of credit relative to direct lending. However, credit intermediaries’ reliance on short- term liabilities to fund illiquid long-term assets is an inherently fragile activity and may be prone to runs. 1 1 There is a large literature on bank runs modeled as multiple equilibria initiated by Diamond and Dybvig (1983). Morris and Shin (2004) provide a model of funding fragility with a unique equilibrium in a setting with higher order beliefs. Martin, Skeie and von Thadden (2011) provide a theory of runs in the repo market. As the failure of credit intermediaries can have large, adverse effects on the real economy (see Bernanke (1983) and Ashcraft (2005)), governments chose to shield them from the risks inherent in reliance on short-term funding by granting them access to liquidity and credit put options in the form of discount window access and deposit insurance, respectively. 2 Shadow banks conduct credit, maturity and liquidity transformation similar to traditional banks. However, what distinguishes shadow banks from traditional banks is their lack of access to public sources of liquidity such as the Federal Reserve’s discount window, or public sources of insurance such as Federal Deposit Insurance. The emergency liquidity facilities launched by the Federal Reserve and other government agencies’ guarantee schemes created during the financial crisis were direct responses to the liquidity and capital shortfalls of shadow banks. These facilities effectively provided a backstop to credit intermediation by the shadow banking system and to traditional banks for their exposure to shadow banks. In contrast to public-sector guarantees of the traditional banking system, prior to the onset of the financial crisis of 2007-2009, the shadow banking system was presumed to be safe due to liquidity and credit puts provided by the private sector. These puts underpinned the perceived risk-free, highly liquid nature of most AAA-rated assets that collateralized credit repos and shadow banks’ liabilities more broadly. However, once private sector put providers’ solvency was questioned, even if solvency was perfectly satisfactory in some cases, the confidence that underpinned the stability of the shadow banking system vanished. The run on the shadow banking system, which began in the summer of 2007 and peaked following the failure of Lehman in September and October 2008, was stabilized only after the creation of a series of official liquidity facilities and credit guarantees that replaced private sector guarantees entirely. In the interim, large portions of the shadow banking system were eroded. The failure of private sector guarantees to support the shadow banking system stemmed largely from the underestimation of asset price correlations by every relevant party: credit rating agencies, risk managers, investors, and regulators. Specifically, they did not account for the fact that the prices of highly rated structured securities become much more correlated in extreme environments than in 3 normal times. In a major systemic event, the price behavior of diverse assets become highly correlated as investors and levered institutions are forced to shed assets in order to generate the liquidity necessary to meet margin calls (see Coval, Jurek and Stafford (2009)). Mark-to-market leverage constraints result in pressure on market-based balance sheets (see Adrian and Shin (2010a), and Geanakoplos (2010)). The underestimation of correlation enabled financial institutions to hold insufficient amounts of liquidity and capital against the puts that underpinned the stability of the shadow banking system, which made these puts unduly cheap to sell. As investors also overestimated the value of private credit and liquidity enhancement purchased through these puts, the result was an excess supply of cheap credit. The AAA assets and liabilities that collateralized and funded the shadow banking system were the product of a range of securitization and secured lending techniques. Securitization-based credit intermediation process has the potential to increase the efficiency of credit intermediation. However, securitization-based credit intermediation also creates agency problems which do not exist when these activities are conducted within a bank. In fact, Ashcraft and Schuermann (2007) document seven agency problems that arise in the securitization markets. If these agency problems are not adequately mitigated with effective mechanisms, the financial system has weaker defenses against the supply of poorly underwritten loans and aggressively structured securities. Overviews of the shadow banking system are provided by Pozsar (2008) and Adrian and Shin (2009). Pozsar (2008) catalogues different types of shadow banks and describes the asset and funding flows within the shadow banking system. Adrian and Shin (2009) focus on the role of security brokers and dealers in the shadow banking system, and discuss implications for financial regulation. The term “shadow banking” was coined by McCulley (2007). Gertler and Boyd (1993) 4 and Corrigan (2000) are early discussions of the role of commercial banks and the market based financial system in financial intermediation. The contribution of the current paper is to focus on institutional details of the shadow banking system, complementing a rapidly growing literature on the system’s collapse As such, our paper is primarily descriptive, and focuses on funding flows in a somewhat mechanical manner. We believe that the understanding of the plumbing of the shadow banking system is an important underpinning of any study of systemic interlinkages within the financial system. The remainder of the paper is organized as follows. Section 2 provides a definition of shadow banking, and an estimate of the size of shadow banking activity. Section 3 discusses the seven steps of the shadow credit intermediation process. Section 4 is by far the longest section of the paper, describing the interaction of the shadow banking system with institutions such as bank holding companies and broker dealers. Finally, section 5 concludes. 2. WHAT IS SHADOW CREDIT INTERMEDIATION? 2.1 Defining Shadow Banking In the traditional banking system, intermediation between savers and borrowers occurs in a single entity. Savers entrust their savings to banks in the form of deposits, which banks use to fund the extension of loans to borrowers. Savers furthermore own the equity and debt issuance of the banks. Relative to direct lending (that is, savers lending directly to borrowers), credit intermediation provides savers with information and risk economies of scale by reducing the costs involved in screening and monitoring borrowers and by facilitating investments in a more diverse loan portfolio. 5 Credit intermediation involves credit, maturity, and liquidity transformation. Credit transformation refers to the enhancement of the credit quality of debt issued by the intermediary through the use of priority of claims. For example, the credit quality of senior deposits is better than the credit quality of the underlying loan portfolio due to the presence of junior equity. Maturity transformation refers to the use of short-term deposits to fund long-term loans, which creates liquidity for the saver but exposes the intermediary to rollover and duration risks. Liquidity transformation refers to the use of liquid instruments to fund illiquid assets. For example, a pool of illiquid whole loans might trade at a lower price than a liquid rated security secured by the same loan pool, as certification by a credible rating agency would reduce information asymmetries between borrowers and savers. Credit intermediation is frequently enhanced through the use of third-party liquidity and credit guarantees, generally in the form of liquidity or credit put options. When these guarantees are provided by the public sector, credit intermediation is said to be officially enhanced. For example, credit intermediation performed by depository institutions is enhanced by credit and liquidity put options provided through deposit insurance and access to central bank liquidity, respectively. Exhibit 1 lays out the framework by which we analyze official enhancements. 2 1. A liability with direct official enhancement must reside on a financial institution’s balance sheet, while off-balance sheet liabilities of financial institutions are indirectly enhanced by the public sector. Activities with direct and explicit official enhancement include on-balance sheet funding Thus, official enhancements to credit intermediation activities have four levels of “strength” and can be classified as either direct or indirect, and either explicit or implicit. 2 The analysis of deposit insurance was formally analyzed by Merton (1977) and Merton and Bodie (1993). 6 of depository institutions; insurance policies and annuity contracts; the liabilities of most pension funds; and debt guaranteed through public-sector lending programs. 3 2. Activities with direct and implicit official enhancement include debt issued or guaranteed by the government sponsored enterprises, which benefit from an implicit credit put to the taxpayer. 3. Activities with indirect official enhancement generally include for example the off-balance sheet activities of depository institutions like unfunded credit card loan commitments and lines of credit to conduits. 4. Finally, activities with indirect and implicit official enhancement include asset management activities such as bank-affiliated hedge funds and money market mutual funds, and securities lending activities of custodian banks. While financial intermediary liabilities with an explicit enhancement benefit from official sector puts, liabilities enhanced with an implicit credit put option might not benefit from such enhancements ex post. In addition to credit intermediation activities that are enhanced by liquidity and credit puts provided by the public sector, there exist a wide range of credit intermediation activities which take place without official credit enhancements. These credit intermediation activities are said to be unenhanced. For example, the securities lending activities of insurance companies, pension funds and certain asset managers do not benefit from access to official liquidity. We define shadow credit intermediation to include all credit intermediation activities that are implicitly enhanced, indirectly enhanced or unenhanced by official guarantees (points 2.), 3.) and 4.) from above). 3 Depository institutions, including commercial banks, thrifts, credit unions, federal savings banks and industrial loan companies, benefit from federal deposit insurance and access to official liquidity backstops from the discount window. Insurance companies benefit from guarantees provided by state guaranty associations. Defined benefit private pensions benefit from insurance provided by the Pension Benefit Guaranty Corporation (PBGC), and public pensions benefit from implicit insurance provided by their state, municipal, or federal sponsors. The Small Business Administration, Department of Education, and Federal Housing Administration each operate programs that provide explicit credit enhancement to private lending. 7 2.2 Sizing the Shadow Banking System Before describing the shadow intermediation process in detail, we begin by reporting a gauge of the size of shadow banking activity. Figure 1 provides two measures of the shadow banking system, net and gross, both computed from the Federal Reserve Board’s flow of funds. The gross measure sums all liabilities recorded in the flow of funds that relate to securitization activity (MBS, ABS, and other GSE liabilities), as well as all short term money market transactions that are not backstopped Exhibit 1: The Topology of Pre-Crisis Shadow Banking Activities and Shadow Bank Liabilities Explicit Impilcit Explicit Implicit Trust activities Tri-party clearing 10 Asset management Affiliate borrowing Federal Loan Programs (DoE, SBA and FHA credit puts) Loan guarantees 3 Government Sponsored Enterprises (Fannie Mae, Freddie Mac, FHLBs) Agency debt Agency MBS Annuity liabilities 4 Securities lending Insurance policies 5 CDS protecion sold Pension Funds Unfunded liabilities 6 Securities lending MTNs Tri-party repo 12 Prime brokerage customer balances Liquidity puts (ABS, TOB, VRDO, ARS) Mortgage Insurers Financial guarantees Financial guarantees CDS protection sold on CDOs Asset management (GICs, SIVs, conduits) Shadow Banks CP 11 ABCP 13 Single-Seller Conduits ABCP 13 Extendible ABCP 17 Extendible ABCP 18 Multi-Seller Conduits ABCP 13 Hybrid Conduits ABCP 13 Extendible ABCP 17 Extendible ABCP 18 TRS/Repo Conduits ABCP 13 Securities Arbitrage Conduits ABCP 13 Extendible ABCP 17 Extendible ABCP 18 Structured Investment Vehicles (SIVs) ABCP 13 MTNs, capital notes Extendible ABCP 18 ABCP 13 MTNs, capital notes Bi-lateral repo 14 Bi-lateral repo 15 Credit Hedge Funds (Standalones) Bi-lateral repo 14 Bi-lateral repo 15 Money Market Intermediaries (Shadow Bank "Depositors") Money Market Mutual Funds $1 NAV Overnight Sweep Agreements $1 NAV Cash "Plus" Funds $1 NAV Enhanced Cash Funds $1 NAV Ultra-Short Bond Funds $1 NAV Local Government Investment Pools (LGIPs) $1 NAV Securities Lenders $1 NAV Source: Shadow Banking (Pozsar, Adrian, Ashcraft, Boesky (2010)) Credit lines to shadow banks 17 Insurance Companies Diversified Broker-Dealers (Investment Bank Holding Companies) Monoline Insurers Direct Public Enhancement Indirect Public Enhancement European Banks (Landesbanks, etc.) Insured deposits 1 Non-deposit liabilities 2 Brokered deposits (ILCs) 7 State guarantees 8 Finance Companies (Standalones, Captives) Brokered deposits (ILCs) 7 Limited Purpose Finance Companies CP 11 ABCP 16 Term ABS, MTNs Extendible ABCP 18 Unenhanced Institution Depository Institutions (Commercial Banks, Clearing Banks, ILCs) Credit lines to shadow banks 9 Increasingly "Shadow" Credit Intermediation Activities [...]... McAndrews (2009): “The Federal Reserve s Primary Dealer Credit Facility,” Federal Reserve Bank New York Current Issues Economics and Finance 15(4) Adrian, Tobias, Dina Marchioni and Karin Kimbrough (2009): “The Federal Reserve s Commercial Paper Funding Facility,” Federal Reserve Bank of New York Economic Policy Review, forthcoming Adrian, Tobias and Hyun Song Shin (2009): “The Shadow Banking System: Implications... banking system These are: (1) the government-sponsored shadow banking sub-system; (2) the “internal” shadow banking sub-system; and (3) the “external” shadow banking sub-system We also discuss the liquidity backstops that were put in place during the financial crisis 4.1 The Government-Sponsored Shadow Banking Sub-System The seeds of the shadow banking system were sown nearly 80 years ago, with the... “Slapped in the Face by the Invisible Hand: Banking and the Panic of 2007” Federal Reserve Bank of Atlanta Jekyll Island Conference Proceedings Martin, Antoine and David Skeie and Elu von Thadden (2011): “Repo runs,” FRB of New York Staff Report No 444 Merton, Robert C (1977): “An Analytical Derivation of the Cost of Deposit Insurance and Loan Guarantees,” Journal of Banking and Finance 1, pp 3-11 Merton,... Government-Sponsored Shadow Banking System The shadow credit intermediation process, and the shadow banking system were to a great extent insipred by the government sponsored enterprises, namely the FHLB system, Fannie Mae and Freddie Mac The GSEs are creations of lawmakers and are off-balance sheet "shadow banks" of the U.S Federal Government The GSEs that make up the government-sponsored shadow banking system... actually being chartered as banks and without having a meaningful access to a lender of last resort and an explicit insurance of their liabilities by the federal government 8 4.2 The “Internal” Shadow Banking Sub-System The development of the GSEs’ activities described above has been mirrored by the evolution of a full-fledged shadow banking system over the past 30 years The shadow banking system emerged... First, the flow of funds does not cover the transactions of all shadow banking entities (see Eichner, Kohn and Palumbo (2010) for data limitations of the flow of funds in detecting the imbalances that built up prior to the financial crisis) Second, we are not providing a measure of the net supply of credit of shadow banks to the real economy In fact, the gross number is summing up all shadow banking liabilities,... proxy for the net supply of credit by shadow banks, but rather as the gross total of securities relating to shadow banking activities The net number mitigates the second problem by netting the money market funding of ABS and MBS However, the net measure is not a measure of the net supply of credit relating provided by shadow banking activities for many reasons Third, many of the securitized assets... irrespective of double counting The gross number should not be The chart uses data from the Flow of Funds Accounts of the United States Traditional liabilities refer to the Total Liabilities of Commercial Banking reported in line 19 of Table L109, which includes U.S.-chartered commercial banks, foreign banking offices in U.S., bank holding companies, and banks in U.S.-affiliated areas Shadow Liabilities... illustrated in Figure 1, the gross measure of shadow bank liabilities grew to a size of nearly $22 trillion in June 2007 We also plot total traditional banking liabilities in comparison, which were around $14 trillion in 2007 5 The size of the shadow banking system has contracted substantially since the peak in 2007 In comparison, total liabilities of the banking sector have continued to grow throughout... The “External” Shadow Banking Sub-System Similar to the “internal” shadow banking sub-system, the “external” shadow banking sub-system is a global network of balance sheets, with the origination, warehousing and securitization of loans conducted mainly from the U.S., and the funding and maturity transformation of structured credit assets conducted from the U.S., but also from Europe and offshore financial . Boesky Shadow Banking REPORTS FRBNY Staff Adrian, Ashcraft: Federal Reserve Bank of New York. Pozsar: International Monetary Fund. Boesky: Bank of America. words: shadow banking, nancial intermediation Shadow Banking Zoltan Pozsar, Tobias Adrian, Adam Ashcraft, and Hayley Boesky Federal Reserve Bank of New York