Andrew Hauser: From lender of last resort to market maker of last resort via the dash for cash - why central banks need new tools for dealing with market dysfunction

Speech by Mr Andrew Hauser, Executive Director for Markets of the Bank of England, at Thomson Reuters Newsmaker, London 7 January 2021.

The views expressed in this speech are those of the speaker and not the view of the BIS.

Introduction

Increasingly we look to financial markets, rather than banks, to care for our savings or provide credit. Millions save via pension, investment or exchange traded instruments. Companies and local authorities hold cash in money market funds. And firms, large and small, borrow from capital markets or non-bank lenders. Taken together, fully half of all financial assets are now held outside the banking system.

These trends aren't new – and to the extent that they bring broader access to cheaper, faster, and more diverse financial services, they're good news. But they do pose novel challenges to financial stability. In particular, as its usage grows, market-based finance seems increasingly prone to liquidity shocks. Some of that reflects vulnerabilities in business models and practices of specific market participants: including liquidity mismatch in funds; leveraged and trend-following investment strategies; or insufficiently forward-looking margining practices. But it also reflects a growing imbalance between the size of key markets, and the balance sheet capacity of banks and dealers who have traditionally helped transfer risk smoothly between investors and borrowers (Chart 1).