Transformed Intermediation: Credit Risk to NBFIs, Liquidity Risk to Banks

We argue that the rapid asset growth of nonbank financial intermediaries (NBFIs) relative to banks is the outcome of transformations of risks between banks and NBFIs that increase the interconnectedness of the two sectors. These transformations are consistent with avoiding tighter, post-GFC bank regulation while harnessing the funding and liquidity advantages of bank deposit franchises and access to safety nets. Specifically, we show that banks fund NBFIs through senior loans and credit lines, which NBFIs use for acquiring junior credit claims, warehouse financing, and liquidity management. We empirically demonstrate that shocks experienced by NBFIs spillover to the banks that provide them with credit lines, particularly in times of stress. We then describe a number of policy approaches that are consistent with our transformation view and conclude with suggestions for future research.