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Systemic Risk from Shadow Banking

A STUDY OF RISK SPILLOVERS FROM CREDIT
INTERMEDIATION OF THE MONEY MARKET FUNDS
Outline 2

 Few definitions: Shadow Banking system, Money Market Mutual Funds

 Purpose and Background
 Working Hypothesis
 Data
 Methodology
 Preliminary Findings
 Conclusion
Few Definitions 3

 The shadow banking system can broadly be described as credit intermediation involving entities and activities
outside the regular banking system (FSB). These do not have access to central bank liquidity or public sector
credit guarantees.
 Finance companies, asset-backed commercial paper conduits, money market mutual funds, limited-purpose finance
companies, structured investment vehicles, credit hedge funds, securities lenders, and government-sponsored
enterprises (Pozsar et al. 2010).
 Money market funds (MMFs) are mutual funds which invest in short-term money market instruments.
 Types of MMFs: Prime, Treasury/Government, Municipal etc.
 Prime MMFs:  Primarily invest in corporate debt securities
 Regulated by SEC in US and ESMA in Europe. Regulators believe that MMFs may contribute to the amplification of global
systemic risk because of
 its size, $4.7 trillion. Possess “money-like” attributes of bank deposits but they do not have “bank-like” insurance, nor
can they access a central bank for liquidity support .
 Sponsor support may have material consequences for the balance sheets of bank sponsors.
 “Narrow banks in mutual fund clothing” (Paul Tucker, Deputy Governor, Bank of England)
Purpose and Background 4

 Study the risk-taking by Shadow banks and the negative spillovers to the broader economy.

 Focus on US Money Market Mutual Funds (MMFs)

 Risk-taking and runs during sovereign debt crisis in 2011.

 Negative consequence on ability of European as well as non-European firms to raise short-term

financing.

 Impact of risky MMFs on non-risky MMFs

 Working Hypothesis 5

Other European
Banks & Eurozone Banks Sovereign
Corporations debt crisis
(Liabilities)
(Liabilities)

Hyp 1: Risk-taking
US Hyp 2: Runs
Pre Period (Jan-May 2011) Inflows MMFs Outflows Post Period (Jun-October 2011)
(Assets)
INVESTORS INJECT MONEY INVESTORS WITHDRAW MONEY

Hyp 3: More exposed

Issuers borrow less Non-European Non-European
Corporations Banks
(Liabilities) (Liabilities)
 Working Hypothesis 6

Hyp 4: More exposed

Funds cut lending more Risky
Eurozone Banks
MMFs
(Liabilities)
Hyp 5: Relationships are
important therefore
Substitution across funds is
not easy
Total
Hyp 6: Risky MMFs drove
MMFs Hyp 7: MMFs squeezed
European bank funding
redemptions in non-risky MMFs
Non-
Risky
MMFs
Data 7

 Novel dataset of security level holdings of US Prime MMFs

funds domiciled in US.
 No of funds: ????
 Asset under management: ?????
 Data Sources
 N-MFP portfolio holdings data filed with SEC
 CUSIP Master file (WRDS, S&P)
 Time period: November 2010 – December 2012
 Focus: January – October 2011
 Pre-crisis period: January-May 2011
 Post-crisis period: June-October 2011
Methodology 8


  Measures of Riskiness or Exposure

 Cross-sectional and panel OLS regressions

Methodology 9

  Hypothesis 1 & 2: MMFs with higher Eurozone exposure receive more inflows in the pre-period
and more outflows in the post-period.
++

 Hypothesis 3: Issuers who borrowed from more exposed MMFs receive less funding in the post-
period.
=

 Hypothesis 4: MMFs with higher exposure cut lending more than less exposed funds
=
Methodology 10

  
Hypothesis 5: Relationships are important in money markets therefore substitution across funds is
not easy.
= ++
 Measures of Relationship strength (Frequency of lending , Maturity, Quantity of lending)

 Hypothesis 6: MMFs with higher exposure drove redemptions in other MMFs in post-period.
++

 Hypothesis 7: Work in progress

Preliminary Findings 11
Other Concerns 12

 Changes in mark-to-market value of funds in post-crisis period

 Alternative sources of funding for the issuers

 Explore frictions other than relationships that exist in Shadow banking in context of
MMFs.
Conclusion 13

 Explore if the risk-taking by Shadow banks can have negative spillover effects to
its borrowers and within industry.

 Explore the importance of relationships in money markets.

 Implications for investors, issuers and policy-makers.

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