A Dose of Reality About the Role of Capital Markets in Financial Stability
Investment Company Institute
ICI is the leading association representing regulated funds globally, including mutual funds, CEFs, ETFs, and UITs.
U.S. Securities and Exchange Commission Chair Gary Gensler in his remarks at the Bloomberg Global Regulatory Forum delivered a much-needed dose of reality about the role of capital markets in financial stability. He underscored three crucial points that are often overlooked or minimized by central bankers and other financial stability policymakers:
These critical benefits must be acknowledged to appropriately calibrate policies around financial stability risk. All too often, policymakers rely on the common misconception that nonbank finance is growing at the expense of the banking sector and poses an escalating threat to the financial system.
Chair Gensler’s comments addressing financial stability risks offer a more balanced perspective than the views expressed by central bankers in recent years. While central bankers tend to focus on eliminating as much risk as possible from the financial system, Chair Gensler recognizes that capital markets seek to deal with risk through price discovery and efficient allocation of capital, as risk is a core feature of financial markets.
Chair Gensler also noted that he wanted to “highlight an additional risk, though one in the banking, rather than nonbank, sector…[that is] US dollar funding offshore in non-US banks.” This is an interesting point.
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Consider what happened in March 2020, as noted in our comment letter to the Financial Stability Board (FSB) in August 2021. Foreign banks and foreign central banks faced with huge demand for US dollars conducted heavy sales of Treasuries, which contributed significantly to the stress in the Treasury market.
Policymakers themselves have acknowledged these developments. In September 2020, then US Treasury Deputy Secretary Justin Muzinich said that “foreign institutions sold nearly $300 billion of Treasuries in March” of that year and added that “[c]entral banks in particular sought dollar liquidity by selling shorter-dated [Treasury] coupon securities in order to raise cash for currency defense and to help meet the liquidity needs of their domestic financial institutions....” Also in September 2020, then Fed Vice Chair and FSB Chair Randy Quarles reported that sales of Treasury securities by foreign central banks were “a significant source” of the March 2020 selloff.
To help stem these stresses, the Fed provided massive amounts of dollar liquidity to global markets through a range of facilities and operations, including $450 billion in loans via swap lines to foreign central banks, which were used to assist non-US banks, and $700 billion in US government securities purchases to stabilize the Treasury and agency MBS markets. As a point of comparison, the Fed only later made available the Money Market Mutual Fund Liquidity Facility, through which money market funds borrowed a more limited amount—$58 billion at its peak.
While Chair Gensler noted that the SEC and other regulators have made significant strides in strengthening markets to better weather situations like March 2020, he also stated that more can be done.
Chair Gensler’s emphasis on doing more by enhancing market resilience aligns closely with ICI’s long-standing recommendations since the 2008 global financial crisis. Rather than targeting specific entities, such as nonbanks, Chair Gensler focuses on the activities that are more likely to contribute to fragility in the system. Most importantly, he notes that nonbank finance, though not without risk, is essential to strong economic growth. As finance ministers, like the ones here in Washington this week for IMF/World Bank meetings, look for ways to spur economic growth, they should pay close attention to Chair Gensler’s message about the critical role capital markets and nonbank finance play in supporting growth. Chair Gensler is absolutely right on this matter.