Non-bank financial intermediaries and financial stability

The heft of non-bank financial intermediaries (NBFIs) has grown significantly after the Great Financial Crisis. This paper reviews structural shifts in intermediation and how NBFIs have shaped the demand for and supply of liquidity in financial markets. We then lay out a framework for the key channels of systemic-risk propagation in the presence of NBFIs, emphasizing the central role of leverage fluctuations through changes in margins. An investor’s debt capacity is increasing in that of other investors in the system, so that leverage enables greater leverage, and spikes in margins can lead to system-wide deleveraging. In our framework, deleveraging and ‘dash for cash’ scenarios (as during the Covid-19 crisis) emerge as two sides of the same coin, rather than being two distinct stress propagation channels. These findings have implications for the design of NBFI regulations and of central bank backstops.