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Liquidity transformation by investment funds: structural fault line or desirable financial transformation? A systemic perspective

Author

Listed:
  • Grill, Michael
  • O´Sullivan, Seán
  • Wedow, Michael
  • Weistroffer, Christian

Abstract

During the market turmoil of March 2020, many money market funds (MMFs) and other investment funds which were exposed to liquidity risk through a liquidity mismatch between their assets and liabilities experienced significant outflows. Those funds reacted in a procyclical manner by either selling assets in already stressed markets or curtailing investors’ access. That behaviour resulted in knock-on effects on other sectors of the economy and amplified the stress within the financial system. This overview article discusses financial stability risks arising from liquidity transformation by MMFs and other investment funds, a subject which is then explored in greater depth in the three other articles in this issue of the Macroprudential Bulletin. While the liquidity transformation carried out by investment funds serves an important economic function, by intermediating savings and real economy financing, it can also generate risks to financial stability. With this in mind, this article argues for a macroprudential approach to the regulation of investment funds to enhance their resilience and facilitate a stable provision of funding to the wider economy in both normal market conditions and periods of market stress. JEL Classification: G01, G23, G28

Suggested Citation

  • Grill, Michael & O´Sullivan, Seán & Wedow, Michael & Weistroffer, Christian, 2021. "Liquidity transformation by investment funds: structural fault line or desirable financial transformation? A systemic perspective," Macroprudential Bulletin, European Central Bank, vol. 12.
    • Handle: RePEc:ecb:ecbmbu:2021:0012:1
    Note: 1280809
    as

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    File URL: https://www.ecb.europa.eu//pub/financial-stability/macroprudential-bulletin/html/ecb.mpbu202104_1~70b30f25c9.en.html
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    Citations

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    Cited by:

    1. Yoshiyasu Koide & Yoshihiko Hogen & Nao Sudo, 2022. "Increasing Portfolio Overlap of Japanese Regional Banks with Global Investment Funds and Its Financial Stability Implications," Bank of Japan Working Paper Series 22-E-15, Bank of Japan.

    More about this item

    Keywords

    ; Financial Stability; Liquidity risk; Money market funds; Open-ended funds; Regulation;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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