Liquidity – Feature


erated by Covid. Indeed, since 2008, the balance sheet of the US Federal Reserve has ballooned to $8.5trn (£6.8trn), from less than $1trn (£810bn) prior to the crisis.


In the wake of the banking crash, regulators responded by clamping down on bank regulation, which in turn resulted in traditional banks gradually retreating from credit provi- sion, while the low yields on traditional fixed income assets caused institutional investors to increase their allocations in private markets. Simultaneously, pension funds and other institutional inves- tors have also employed increased leverage in their portfolios to compensate for the low returns in traditional fixed income assets. The Financial Stability Board (FSB) defines non-bank financial intermediation, the regulatory term for shadow banking, as


maturity transformation (the use of short-term funds to invest in longer-term assets), liquidity transformation, (which involves the use of cash-like liabilities to buy illiquid assets such as loans) and the use of leverage to magnify potential investment returns. As such, it could be argued that institutional investors from pension funds to insurance companies, have become a cornerstone of the rapidly growing shadow banking sector. The FSB estimates that non-bank financial intermediation assets, the regulatory term for shadow banking assets, now account for nearly half of all financial sector assets and stood at $63.2trn (£51.2trn), or 48.3% of total financial assets, in 2020. In doing so, pension funds, insurers and other financial inter- mediaries play a role in providing liquidity in a world where banks are retreating from liquidity provision. But unlike banks, which are required to hold capital in reserve, the capital


Issue 120 | February 2023 | portfolio institutional | 35


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