3. The EU Shadow Banking Market

See EU Commission, (2014), European Financial Stability and Integration, pp. 94–95.

EU Commission, (2014), ibid., p. 96.

EU Commission, (2014), ibid., p. 97.

I will not rehash here the different critiques already discussed that emerged regarding that FSB definition. The critiques involved either the fact that (1) the FSB definition focus on activities outside the regular banking system may underestimate the role played by large regulated banking groups (something that will be discussed extensively going forward); (2) the FSB definition may cover entities that should not be thought as being part of the shadow banking sector based on a liquidity, maturity, leverage and interconnectedness risk assessment (such as leasing companies, finance companies, corporate tax vehicles); and (3) the FSB definition may not allow to proactively detect new shadow banking activities. Some commentators put the focus on the presence of a backstop or safety net and on systemic risk and propose as an alternative definition for shadow banking ‘all financial activities, except traditional banking, which require a private or public backstop to operate’.

EU Commission, (2014), ibid., p. 97.

See EBA, (2014), Report to the European Commission on the Perimeter of Credit Institutions Established in the Member States, November. Part three (pp. 16–24).

EBA, (2014), ibid., p. 16.

P.-N. Rehault, (2013), Understanding Shadow Banking from a European Perspective, Université de Limoges Working Paper, March 7.

That distinction was already found back in A. Bouveret, (2011), An Assessment of the Shadow Banking Sector in Europe, ESMA Working Paper.

ESRB, (2014), Mapping and Risks of the EU Shadow Banking System, non-public 30 January 2014, interim Report.

For Europe-specific assessments, see: ESMA (2014), Trends, Risks, Vulnerabilities, Vol. 2, pp. 21–22 with estimations of maturity and liquidity exposures, ESRB, (2014), Mapping and Risks of the EU Shadow Banking System, non-public 30 January 2014 interim report, and K. Bakk-Simon, (2012), Shadow Banking in the Euro Area: An Overview, ECB Occasional Paper Series Nr. 133, April, and A. Bouveret, (2011), An Assessment of the Shadow Banking Sector in Europe, ESMA Working Paper.

See also: C. Jackson and J. Matilainen, (2012), Macro-Mapping the Euro Area Shadow Banking System with Financial Sector Balance Sheet Statistics, IFC Conference on Statistical Issues and Activities in a Changing Environment, Working Paper, Basel, 28–29 August 2012.

Data source: sifma.​org, period 2008–2019, quarterly and annual reports. It was observed that the numbers of SIFMA and AFME do not (fully) match in terms of securitization issuance. See: Afme, (2015), Afme Securitization: Q3, 2015 Data Snapshot, London, p. 1. One can only wonder what caused these (often large) variations as both institutions do not provide details regarding the methodology or granularity of their data set. Similar deviations were observed in historical data sets; see: Afme, (2015), Securitization Data Report, Q2: 2015, London, pp. 3–5. Number don’t add up to 100%, due to miscellaneous unreported group of 0.6 billion (2018).

Discussed in the CMU section. It is discussed why SME securitization is lagging and why no plan will really change that unless it includes revising the capital requirements for banks and the SME loan book. Nevertheless, for some EU countries the suggested reform lacks ambition; see M. Stothard and J. Brunsden, (2015), France Warns that EU Securitisation Push Lacks Ambition, Financial Times, October 26. It comes down to the alleged need to have an EU body that will decide on whether securitization products meet the critical standard of ‘simple transparent and standardized’ (and which would allow the issuer to hold lower capital charges against the product). At this point it is the national regulator who decides on the matter. The argument is that without a consistent approach in this matter only the biggest investors would have the expertise and resources necessary to take part in the market. That would be not sufficient to create the looked for ‘revival’. The EC counterargument is that a centralized approval system would materially slow down the approval process which obviously also doesn’t contribute to a ‘revival’. Although a valid argument in this context, it can be questioned what is different within the larger banking union and its many dark corners where supervision and oversight also have been centralized on an EU level and where in case of an organized unwinding of a banking institution a myriad of mechanisms comes into force that does right to a truly post-modern era.

Obviously, the industry lobby in Europe feels different about that AFME, (2013), The Economic Benefits of High Quality Securitisation to the EU Economy, November, p. 21. Please further note that even they indicate that ‘The specific impact of renewed securitisation on growth has not been quantified, but could be significant in terms of GDP’ (p. 2). That is followed by a list of assumptions, abstractions, non-sequiturs, cum hoc ergo propter hoc and so on. See also: AFME, (2014), High Quality Securitization for Europe. The Market at a Crossroads, June; Ignazio Visco, (2015), Investment Financing in the European Union, keynote address by Mr. Ignazio Visco, Governor of the Bank of Italy, at OECD-Euromoney Conference on Long-Term Investment Financing, Paris, 19 November 2015.

Risk Control, (2015), How European Securitisation Could Assist SME Financing, Nr. 15.67a, June 16, p. 5.

See, for example, P. Francorre, (2014), Revival of Securitisation: Why and How?, Working Paper, mimeo.

A.G. Anderson, (2015), Ambiguity in Securitization Markets, Finance and Economics Discussion Series Nr. 2015-033, Divisions of Research & Statistics and Monetary Affairs Federal Reserve Board, Washington, DC, May.

See for a generic overview of the European securitization market: ECB, (2011), Recent Developments in Securitization, February, Frankfurt.

K. Bakk-Simon et al., (2012), Shadow Banking in the Euro Area. An Overview, Occasional Paper Series Nr. 133, Frankfurt April. See also Deutsche Bundesbank, (2014), The Shadow Banking System in the Euro Area: Overview and Monetary Policy Implications, Monthly Report, March, pp. 15–34. See also the ECB Financial Stability Review 2014 and 2015, Frankfurt.

Although they are often reported as being part of it: ECB, (2011), Recent Developments in Securitization, February, Frankfurt, pp. 16–21.

O.C. Brañanova, (2017), Shadow Banking in Spain, Working Paper, mimeo, via bis.​org

See AFME, (2015), Securitization Data Report, Q4 2014, April 8, p. 4.

K. Bakk-Simon et al., (2012), ibid., pp. 21–23.

This overview is complete with respect to the major legislative documents and policies frameworks developed and enacted. It falls short to be totally exhaustive and include all technical standards and other policy document or delegated legislation enacted. See for a complete overview and update ec.europe.eu.

See AFME, (2015), Securitization Data Report, Q4 2014, April 8, p. 2; and future quarterly annualized reports. Latest included Q1, 2019.

EC, (2015), Council of the European Union Agrees on Commission Proposal for Simple and Transparent Securitisation, STATEMENT/15/6239, December 2.

See, for example, D. Nouy, (2013), Les risques du Shadow banking en Europe: le point de vue du superviseur bancaire, ACP, Banque de France, Débats économiques et financiers, Nr. 3. See for an overview of the contemporary bank business models and their evolution: R. Roengpitya et al., (2014), Bank Business Models, BIS Quarterly Review, December 2014, pp. 55–65. And for the US: M. Ricks, (2010), The Case for Regulating the Shadow Banking System, Vanderbilt Law School Working Paper, Mimeo, and I.A. Moosa, (2015), The Regulation of Shadow Banking, Journal of Banking Regulation advance online publication 12 August 2015; doi: https://​doi.​org/​10.​1057/​jbr.​2015.​8

See, for example, Ph. Tibi, (2013), Shadow Banking Versus Shadow Market, Sciences Po-Banque de France, 13 February.

J. Weidmann, (2019), Macroprudential policy through the lens of Sherlock Holmes. Welcome address by Dr. Jens Weidmann, President of the Deutsche Bundesbank and Chairman of the Board of Directors of the Bank for International Settlements, at the 5th Annual Macroprudential Conference, Eltville, 21 June 2019, via bis.​org

See in detail: M. Ricks, (2011), Regulating Money Creation After the Crisis, Harvard Business Law Review, Vol. 1, pp. 75–143. The article describes a variety of legal, accounting and economic contexts in which non-deposit money-claims are treated as functional substitutes for deposit obligations. The system creates investible capital or loanable funds (pp. 99–101).

EU Commission, (2014), ibid., pp. 107–108. Many new disclosures and due diligence rules and requirements and skin in the game protocols have been implemented in recent years.

Securitization was believed to provide (1) superior balance-sheet management, (2) superior portfolio and risk management, (3) superior funding management, (4) better price discovery by liquefying previously illiquid asset and (5) lower capital requirements.

EU Commission, (2014), ibid., p. 109.

N. Cetorelli and S. Peristiani, (2012), The Role of Banks in Asset Securitization, FRB NY Economic Policy Review, Vol. 18, Issue 2, pp. 47–60.

V.V. Acharya, et al., (2010), Securitisation Without Risk Transfer, NBER Working Paper Nr. 15730.

ESRB, (2014), Mapping and Risks of the EU Shadow Banking System, non-public 30 January 2014, interim report.

EU Commission, (2014), ibid., p. 111.

EU Commission, (2014), ibid., p. 112.

A. Barker and C. Binham, (2015), EU Seeks to Relax Securitization Rules, Financial Times, February 17.

Which is a joint effort of the ECB and the bank of England; see C. Jones and A. Bolger, (2014), BoE and ECB Make Fresh Push to Revive Loan Bundles, Financial Times, May 30.

Communication from the Commission to the European Parliament and the Council on Long-Term Financing of the European Economy, COM(2014) 168 final, via ec.​europe.​eu

Disclosure initiatives introduced by the ECB, which require banks that use their asset-backed securities as collateral for repurchase (repo) financing to report securitized loan characteristics and performance in a standardized format starting from 2013, were used to observe the effect of transparency on loan quality in case of securitization. They find that securitized loans originated under the transparency regime are of better quality with a lower default probability, lower delinquent amount, fewer days in delinquency and lower losses upon default. Additionally, banks with more intensive loan-level information collection on their borrowers and those operating in more transparent credit markets experience greater improvement in their loan quality under the new reporting standards; A. Ertan et al., (2015), Enhancing Loan Quality Through Transparency: Evidence from the European Central Bank Loan Level Reporting Initiative, Working Paper, August, mimeo.

EU Commission, (2014), ibid., p. 115.

EC, (2015), Consultation Document, An EU Framework for Simple, Transparent and Standardised Securitisation, February 18.

ECB and BoE, (2014), The Case for a Better Functioning Securitisation Market in the European Union, A Discussion Paper, Frankfurt/London.

EC, (2015), Consultation Document, An EU Framework for Simple, Transparent and Standardised Securitisation, February 18, p. 4.

BCBS, (2014), Criteria for Identifying Simple, Transparent and Comparable Securitisations – Consultative Paper, Basel, Switzerland. I stay short of reviewing the new criteria as it would deviate it too much from the central questions that relate to the risk of securitization instruments in a market-based financing system. However, a few words can be said about the systematic set-up of their analysis: (1) Criteria promoting simplicity refer to the homogeneity of underlying assets with simple characteristics, and a transaction structure that is not overly complex. (2) Criteria on transparency provide investors with sufficient information on the underlying assets, the structure of the transaction and the parties involved in the transaction, thereby promoting a more comprehensive and thorough understanding of the risks involved. The manner in which the information is available should not hinder transparency, but instead it should support investors in their assessment. (3) Criteria promoting comparability could assist investors in their understanding of such investments and enable more straightforward comparison across between securitization products within an asset class. The proposed criteria (14) have been mapped to key types of risk in the securitization process: (1) generic criteria relating to the underlying asset pool (asset risk), (2) transparency around the securitization structure (structural risk) and (3) governance of key parties to the securitization process (fiduciary and servicer risk).

BCBS, (2014), Criteria for Identifying Simple, Transparent and Comparable Securitisations, Basel, July. And the implementation of the (lower) capital charges for compliant STS securitized products; see BCBS, (2015), Capital Treatment for ‘Simple, Transparent and Comparable’ Securitisations, Consultative Document, November, Basel.

These include the Capital Requirements Regulation for banks, the Solvency II Directive for insurers, and the UCITS and AIFMD directives for asset managers. Legal provisions, notably on information disclosure and transparency, are also laid down in the Credit Rating Agency Regulation (CRAIII) and the Prospectus Directive. There are also elements related to the prudential treatment of securitization in Commission legislative proposals currently under negotiation. Provisions are also included in delegated acts. Non-legislative provisions may also have an important role, especially accounting standards (e.g. IAS 39, IFRS 10, IFRS 7).

EC, (2012), Non-Bank Financial Institutions: Assessment of Their Impact on the Stability of the Financial System, Economic Papers Nr. 472, November, p. ix.

‘These include size and interconnectedness particularly. That is, the larger the institutions involved, the bigger the effect of any risk to financial stability materialising. Similarly, the more inter-connected the institutions involved the bigger the effect insofar as there are likely to be a greater number of institutions involved. Regulatory features can also act as a multiplier’ (p. ix).

EC, (2012), Non-Bank Financial Institutions: Assessment of Their Impact on the Stability of the Financial System, Economic Papers Nr. 472, November, p. ix.

EC, (2012), Non-Bank Financial Institutions: Assessment of their Impact on the Stability of the Financial System, Economic Papers Nr. 472, November, p. x.

EC, (2012), Non-Bank Financial Institutions: Assessment of Their Impact on the Stability of the Financial System, Economic Papers Nr. 472, November, p. xi.

EC, (2012), Non-Bank Financial Institutions: Assessment of Their Impact on the Stability of the Financial System, Economic Papers Nr. 472, November, p. xi.

ESRB, (2015), Annual Report 2014, pp. 27–29. Also ESRB 2016–2018 via esrb.​europe.​eu

EC, (2013), Communication from the Commission to the Council and the European Parliament, Shadow Banking – Addressing New Sources of Risk in the Financial Sector, COM(2013) 614 final.

T. Adrian et al., (2013), Shadow Bank Monitoring, FRB NY Staff Report, NR. 638, NY.

A. Turner, (2012), Shadow Banking and Financial Stability, 14 March, Cass Business School speech and A. Turner, (2012), Securitisation, Shadow Banking and the Value of Financial Innovation, Rostov lecture on international affairs, School of Advanced International Studies, Johns Hopkins University, 19 April. EU Commission, (2014), ibid., p. 123.

See for a permanent evaluation model for systemic risk in the EU the quarterly ESRB Risk Dashboard (www.​esrb.​europa.​eu/​pub/​rd). The first item of the dashboard is often ‘Interlinkages and composite measures of systemic risk’.

FSB, (2013), Strengthening Oversight and Regulation of Shadow Banking: Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos, August, Basel.

ESRB (J. Keller et al.), (2014), ibid., pp. 6–8.

ESRB (J. Keller et al.), (2014), Securities Financing Transactions and the (Re)use of Collateral in Europe, An Analysis of the First Data Collection Conducted by the ESRB from a Sample of European Banks and Agent Lenders, ESRB Occasional Paper Series, Nr. 6, September, pp. 3–6, 51–55.

See in detail: ESRB (J. Keller et al.), (2014), ibid., pp. 10–12.

See in detail: ESRB (J. Keller et al.), (2014), ibid., pp. 12–21, 40–42.

See in detail: ESRB (J. Keller et al.), (2014), ibid., pp. 21–26.

See in detail: ESRB (J. Keller et al.), (2014), ibid., pp. 40–42.

But with material differences when observed at the micro-level of individual financial institutions (FIs); see in detail: ESRB (J. Keller et al.), (2014), ibid., pp. 26–37.

See in detail: ESRB (J. Keller et al.), (2014), ibid., pp. 42–49.

See in detail: ESRB (J. Keller et al.), (2014), ibid., pp. 49–51.

See in detail: ESRB (J. Keller et al.), (2014), ibid., pp. 55–56.

FSB, (2011), Shadow Banking: Scoping the Issues, Financial Stability Board.

Especially now that a large chunk of the increasing global wealth is managed by a select set of very large global asset managers.

As defined by the FSB in: FSB, (2012), FSB, Global Shadow Banking Monitoring Report 2012, p. 20.

See, for example, E. Jeffers and C. Baicu, (2013), The Interconnectedness Between the Shadow banking System and the Regular banking System. Evidence from the Euro Area, Cityperc Working Paper Series, Nr. 2013/7. They focus on data up till 2012.

That is also true for the UK relative to the US.

J. Tyson, and M. Shabani, (2013), Sizing the European Shadow Banking System: A New Methodology, City University London (Cityperc) Working Papers, Nr. 2003/1, p. 6.

Group of Ten, (2001), Consolidation in the Financial Sector, via bis.​org

S. Hsu, et al., (2013), Shadow Banking and Systemic Risk in Europe and China, City University London, Cityperc Working Paper Series, Nr. 2, p. 1.

Hsu et al., (2013), ibid., p. 6, and J. Li, et al., (2012), The Annual Report of China Shadow Banking System. Project Sponsored by the National Natural Science Foundation of China, Project Number 71173246.

Hsu et al., (2013), ibid., p. 8.

Although the size of that segment has been materially rising after the many rate cuts by the Chinese central bank in 2014–2015 to keep the real economy going.

Hsu et al., (2013), ibid., pp. 8–10.

Hsu et al., (2013), ibid., p. 15.

S. Hsu et al., (2013), ibid.

Hsu et al., (2013), ibid., p. 13.

See for a comparison between the regulatory efforts between the EU, US and the FSB: E.F. Greene and E.L. Broomfield, (2013), Promoting Risk Mitigation, Not Migration: A Comparative Analysis of Shadow Banking Reforms by the FSB, USA and EU, Capital Markets Law Journal, Vol. 8, Nr. 1, pp. 6–53.

When hell broke loose in 2008/2009, the European central banks provided USD liquidity to ailing European banks as they in turn, through the ECB, have a USD swap line with the US Federal Reserve Bank.

T. Harford, (2011), What We Can Learn From a Nuclear Reactor, Financial Times, 11 January.

A.G. Haldane, (2015), On Microscopes and Telescopes. Speech at the Lorentz Center workshop on socio-economic complexity. Leiden, Netherlands, March 27. Haldane identifies four layers: (1) the ‘microprudential’ layer of individual firms, (2) the ‘macroprudential’ layer of the financial system, (3) the ‘macro-economic’ layer of the national economy, monitored through monetary policy, and (4) the ‘telescope’ layer of the global economic and financial system which is managed through the international financial architecture; see EC, (2015), Commission Staff Working Document. European Financial Stability and Integration Review, April 2015, pp. 61–62. See also: G. Hautony, and J.C. Héamz, (2014), How to Measure Interconnectedness between Banks, Insurers and Financial Conglomerates? Autorité de Contrôle Prudentiel et de Résolution (France); O. Castrén and M. Rancan, (2013), Macro-Networks. An Application to the Euro Area Financial Accounts, ECB Working Paper Nr. 1510, Frankfurt.

See extensively on the dynamics and segments of the EU financial infrastructure: EC, (2015), ibid., pp. 35–114. Questions answered are: who is providing credit, who is using this credit, in which form the credit is formalized or through which channels financial resources flow? Also reviewed are the ‘preferences of markets participants as reflected in the mix of products they choose to invest in or to use as a source of funding. These customer preferences in the provision and use of funding determine the importance and role that the financial sector, and its different segments, is to play in the European economy’ (p. 8).

See for the interconnectedness and the amounts flowing through the linkages between the different segments of the European financial infrastructure: EC, (2015), ibid., p. 60.

EC, (2015), ibid., p. 8. The since 2016 launched ESRB annual shadow banking SB monitor, documents and details and changes of the different segments; The ECB also reports some of its findings in the bi-annual financial stability report.

See in particular EC, (2015), ibid., pp. 59–60.

See for more details: EBA, (2015), Draft EBA Guidelines on limits on exposures to shadow banking entities which carry out banking activities outside a regulated framework under Article 395 para. 2 Regulation (EU) Nr. 575/2013, EBA/CP/2015/06, March 19. Final guidelines were issued 14 December 2015 under reference EBA/GL/2015/20, via eba.​europe.​eu

The intention is to focus on institutions’ exposures to entities that pose the greatest risks in terms of the direct exposures institutions face and also the risk of credit intermediation being carried out outside the regulated framework.

‘Credit intermediation activities’ are defined as bank-like activities involving: (1) maturity transformation, (2) liquidity transformation, (3) leverage, (4) credit risk transfer or (5) similar activities.

In fact the EBA initially left two options open: (1) apply the 25% limit to the sum of all exposures to shadow banking entities, (2) apply the 25% limit only to the sum of the exposures to shadow banking entities to which the institution is not able to apply the criteria defined in the guidelines (and apply the principal approach to set out individual limits for the remaining exposures and to set out an aggregate limit for all exposures).

See, for example, Deutsche Bundesbank, (2014), The Shadow Banking System in the Euro Area: Overview and Monetary Implications, Monthly Report, March, pp. 21–22.

EBA, (2014), Guidelines on Significant Credit Risk Transfer relating to Articles 243 and Article 244 of Regulation 575/2013, EBA/GL/2014/05, July 7.

See, for example, on securities financing: FSB, (2014), Standards and Processes for Global Securities Financing Data Collection and Aggregation, Consultative Document, Basel, November 13.

ECB, (2014), Financial Stability Review, November 2014, Frankfurt, p. 9.

ECB, (2014), ibid., p. 10.

ECB, (2014), ibid., pp. 43–44.

ECB, (2014), ibid., p. 80.

ECB, (2015), Financial Stability Review, April 2015, Frankfurt, pp. 12–13.

ECB, (2015), ibid., p. 87.

For a review of the European banking sector and characteristics and individual segments, see ECB, (2015), ibid., pp. 87–99, and EC, (2015), European Financial Stability and Integration, April, pp. 85–86.

ECB, (2015), ibid., pp. 88–89.

For an evaluation of the implications, see ECB, (2015), ibid., pp. 102–104.

ECB, (2015), ibid., pp. 126, 132.

Y. Altunbas et al., (2014), Does Monetary Policy Affect Bank Risk, International Journal of Central Banking, March, pp. 95–135, and C. Gauthier et al., (2014), Introducing Funding Liquidity Risk in a Macro Stress-Testing Framework, International Journal of Central Banking, December, pp. 105–141.

G. Ordoñez, (2015), Sustainable Shadow banking, Working Paper, January and O. Lucius, (2014), In Search of Financial Stability – the Case of Shadow Banking, Managerial Economics Vol. 15 Nr. 1, pp. 63–81.

ECB, (2015), Financial Stability Review, November, pp. 6, 13–15.

See in detail: ECB, (2015), Financial Stability Review, November, pp. 97–107.

ECB, (2015), ibid., pp. 102–103.

See ECB, (2015), ibid., p. 104, for a comparison and benchmarking against the other scenarios.

ECB, (2015), ibid., p. 106. Credit risk implies a decline of about 1.5% in net asset values expressed as a percentage of total assets. This outcome is driven mainly by corporate credit risk.

Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories, O.J. L 201 pp. 1–59 of 27.7.2012.

There have been standards issued so far regarding the following topics and issues: (1) regulatory technical standards on capital requirements for central counterparties; (2) regulatory technical standards on requirements for central counterparties; (3) regulatory technical standards on indirect clearing arrangements, the clearing obligation, the public register, access to a trading venue, nonfinancial counterparties, risk mitigation techniques for OTC derivatives contracts not cleared by a CCP; (4) regulatory technical standards on the minimum details of the data to be reported to trade repositories; (5) regulatory technical standards specifying the details of the application for registration as a trade repository; (6) regulatory technical standards specifying the data to be published and made available by trade repositories and operational standards for aggregating, comparing and accessing the data.

See, for example, recently for the clearing of interest rate swaps and other interest rate derivatives: ESMA, (2015), Consultation paper Nr. 4 on the clearing obligation under EMIR, Nr. 2015/807 of May 11.

IOSCO/BCBS, (2013), Margin Requirements for Non-centrally Cleared Derivatives, Basel, September.

IOSCO, (2015), Risk Mitigation Standards for Non-centrally Cleared OTC Derivatives, FR01/2015, January 28.

See, for example, E.N. White, (2007), The Crash of 1882, Counterparty Risk, and the Bailout of the Paris Bourse, National Bureau of Economic Research (NBER) Working Paper Nr. 12933; B. Coeuré, (2014), The Known Unknowns of Central Clearing, Speech at the meeting on global economy and financial system hosted by the University of Chicago Booth School of Business Initiative on Global Markets at Coral Gables, Florida, March 29.

C. Boissel et al., (2014), Systemic Risk in Clearing Houses: Evidence from the European Repo market, Working Paper, December 4, mimeo. They examined the European sovereign repo market which is considered the safest segment of the European repo market in which the CCP assumes counterparty default risk.

There is an obvious relation between repo rates and a country’s CDS spread, which can be used as a proxy for the intensity of sovereign stress (repo rate-to-CDS spread sensitivity). Boissel et al. find a strong positive relation between the CDS spreads of sovereign debt issued by European countries and the rates of repo transactions using the same sovereign debt as collateral. This relation is the strongest at the peak of the sovereign debt crisis in the eurozone, in 2011, and is concentrated in the countries that were affected the most by the crisis (GIIPS).

C. Boissel et al., (2014), ibid., pp. 3–5, 20–22, 24–33; also see A.J. Menkveld, (2014), Crowded Trades: An Overlooked Systemic Risk for Central Clearing Counterparties, VU University Amsterdam Working Paper and A.J. Menkveld, (2014), Systemic Liquidation Risk: Centralized Clearing, Margins, and the Default Fund, VU University Amsterdam Working Paper.

L. Mancini, et al., (2014), The Euro Interbank Repo Market, Working Paper, mimeo; A. Martin, et al., (2014), Repo Runs, Review of Financial Studies Vol. 27, Issue 4, pp. 957–989. The other fact is that both markets differ significantly in composition: in Europe approximately 56% of the market consists of transactions conducted on electronic platforms offering clearing services via a CCP, 33% of bilateral (non-CCP) transactions and only roughly 11% of tri-party repos: ECB, (2012), European Money Market Survey. European Central Bank/Eurosystem (December).

See for an annual update on the status of the CMU project the Financial Stability and Integration Review, via ec.europa.eu.

EC, (2015), Capital Markets Union: An Action Plan to Boost Business Funding and Investment Financing, Press release, Brussels, September 30. That was following the fact that the EBA provided an opinion on a European Framework for Qualifying Securitizations; EBA, (2015), Opinion of the European Banking Authority on a European framework for qualifying securitisation, EBA/Op/2015/14 of July 7, and EBA, (2015), EBA Report on Qualifying Securitization. Response to the Commission’s Call for Advice of January 2014 on Long-Term Financing.

Based on EC, (2015), A European Framework for Simple and Transparent Securitisation, September 30, via ec.​europe.​eu

Ibid.

Ibid.

Ibid.

Proposal for a Regulation of the European Parliament and of the Council laying down common rules on securitisation and creating a European framework for simple, transparent and standardised securitisation and amending Directives 2009/65/EC, 2009/138/EC, 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012 COM(2015) 472 final, September 30.

E. Engelen and A. Glassmacher, (2015), The Trojan Horse of Europe’s Capital markets, via Ftm.nl, September 30.

Many positions in the EC memorandum regarding the securitization proposal seem to reflect thoughts and opinions found back in the BCG report ‘Bridging the Growth Gap’ commissioned by the Association for Financial Markets (AFME), the largest Brussels-based financial lobby group. All the more suspicion is justified when reading in the most recent AFME report (p. 4): ‘[s]ince June 2015, we have undertaken an outreach program to meet with key policymakers and opinion formers on CMU – including Commission officials, finance ministries and central banks, MEPs and think-tanks…’ ‘We will continue to be active and closely engaged across the CMU agenda, including in areas such as infrastructure, securitisation and SME funding, which are vital to promoting growth. In December 2015, together with Euromoney and ICMA, we will hold a conference in Brussels on CMU. Commissioner Hill is confirmed as keynote speaker, and this event should provide the opportunity for the industry to respond in detail to the Commission’s action plan.’ The fruitful interaction between all stakeholders and the EC in the run-up to this proposal seems to turn out being that 110 of the 120 representatives were industry parties.

See the securitization chapter for references.

Those include: (1) ECB/BoE, (2014), Synthesis of the consultation on securitization, October, (2) The BCBS-IOSCO consultative Document on Criteria to Identify, Transparent and Comparable Securitisation Instruments, Consultative Document, December, (3) the EBA Discussion Paper (2014) on Simple and Transparent Securitizations, October, (4) BCBS, (2014), Revisions to the Securitization Framework, December, (5) the EC Communication (2014) from the Commission to the European parliament and the Council on Long-Term Financing of the European Economy COM(2014)168 final of 27 March. They are discussed in the dedicated securitization chapter.

The EU comments on the issue of how securitization contributes to economic growth and job creation as follows: ‘[t]he new, more risk-sensitive provisions on regulatory capital requirements and the introduction of specific criteria for STS securitization will make investing in safer and simpler securitization products more attractive for credit institutions established in the Union and release additional capital for lending to enterprises and households. Historically, credit institutions have been the main investors in European securitizations. In the future, the CMU’s objective is to expand the investor base of Union securitization markets by making it more attractive for non-bank investors to fund securitization exposures. Nevertheless, it is likely that credit institutions will form a large part of securitization’s investor base in the EU’; EC, (2015), A European Framework for Simple and Transparent Securitisation, September 30.

Data set EU Securitization Forum

S. Agarwal et al., (2015), Do Banks Pass Through Credit Expansion? The Marginal Profitability of Consumer Lending During the Great Recession, Berkeley University, Haas School of Business Working Paper, August 30. Later on adjusted and published as S. Agarwal et al., (2018), Do Banks Pass through Credit Expansions to Consumers Who want to Borrow, The Quarterly Journal of Economics, Vol. 133, Issue 1, pp. 129–190.

EBA, (2015), Opinion of the European Banking Authority on a European framework for qualifying securitization, July 7, and in particular EBA, (2015), EBA Technical Advice on Qualifying Securitisations, 26 June, London. See also, (2014), EBA Report on Qualifying Securitisation, December, London. It was written in parallel legislation with the securitization directive. See for the details the securitization chapter (Vol. I, chap. 3).

To be precise: Proposal for a Regulation of the European Parliament and of the Council amending regulation No 573/2013 on prudential requirements for credit institutions and investment firms, COM(2015)473 final, 30 September.

According to the Memorandum accompanying the securitization proposal STS implies: (1) assets packaged in securitization must be homogeneous loans/receivables (e.g. car loans with car loans, residential mortgages with residential mortgages); (2) no securitization of securitizations is allowed; (3) loans must have a credit history long enough to allow reliable estimates of default risk; (4) the ownership of a loan must have been transferred to the securitization issuer (i.e. they must be sold by the creator of the loans to the entity that will issue the securitization); (5) loans packaged in securitization must have been created using the same lending standards as any other loan, no ‘cherry-picking’ allowed; (6) At least 5% of the loans portfolio must be retained by the originator; (7) documents must provide details of the structure used and the payment cascade (i.e. the sequence and amount of payments to each tranche); (8) data on packaged loans must be published on an ongoing basis and (9) the contractual obligations, duties and responsibilities of all key parties to the securitization must be clearly defined. The issuing bank is legally responsible for any misrepresentation. The Commission’s proposal includes precise disclosure requirements from the originator, the sponsor and the issuer. These will be jointly responsible for providing to the investors all the relevant information needed to perform proper due diligence and assess the securitization’s riskiness. Synthetic securitizations carry additional legal and counterparty risks that need to be taken into consideration, and. As a consequence, some of the more complex synthetic products generated much higher losses than those generated by simple and transparent structures. Precise criteria to identify more simply synthetic securitizations are being developed by the European Banking Authority and the Commission stands ready to consider the inclusion of any such criteria developed.

J. Brunsden and T. Hale, (2015), EU Plan to Revive ABS Faces Challenges, Financial Times, September 30.

Ibid. ‘A similar security that provides bank funding, but does not involve moving assets off bank balance sheets — and the securities would still face tougher capital requirements compared with the underlying assets, had they been left unbundled.’

P. Teffner, (2015), Hill, Capital Markets Union Will Not Swing EU Referendum, EUobserver.​com, November 5.

This section is put in place only for introductory purposes. For detail and analysis, see the securitization chapter (Vol. I, chap. 3). It is based on the preamble of the STS regulation: REGULATION (EU) 2017/2402 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 12 December 2017 laying down a general framework for securitization and creating a specific framework for simple transparent and standardized securitization, and amending Directives 2009/65/EC, 2009/138/EC and 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012, O.J. L 347/35 ff. of 28 December 2017.

Based on Proposal for a Regulation of the European Parliament and of the Council laying down common rules on securitization and creating a European framework for simple transparent and standardized securitization and amending Directives 2009/65/EC, 2009/138/EC, 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012 COM(2015) 472 final, September 30, pp. 13–18, and its final version: Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for securitisation and creating a specific framework for simple, transparent and standardised securitisation, and amending Directives 2009/65/EC, 2009/138/EC and 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012, OJ L 347, 28.12.2017, pp. 35–80.

See in detail: T. Hale, (2015), Complexity Lurks in EU Simpler Securitization Plan, Financial Times, October 27.

See the Explanatory Memorandum accompanying the Proposal for a Regulation of the European Parliament and of the council amending Regulation (EU) No 575/2013 on prudential requirements for credit institutions and investment firms of 30 September 2015 (COM(2015)473 final), pp. 2–11 and the final regulation (preamble): Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 Text with EEA relevance OJ L 176, 27.6.2013, p. 1–337. The most significant changes are: a new hierarchy of risk calculation methods and lower capital requirements for STS, to lower costs for credit provision and unlock additional sources for long-term finance, especially to SMEs. The Council agreed on a general approach on 7 December 2015. There was a lengthy debate between EP and the Council on a number of issues including the hierarchy of approaches and securitization of SME loans. The European Parliament and the Council reached an agreement on 30 May 2017 on this and the related STS topic. The compromise entails a preferential capital treatment for STS securitization, a new hierarchy for risk calculation methods, including a differentiation between STS and non-STS and between senior and other tranches, as well as easing financing of SMEs via a specific treatment for the safer forms of synthetic securitizations of SME loans.

Based on EC, (2015), Consultation Document Covered Bonds in the European Union, September 30, pp. 3 ff.

Regarding the aspects of encumbered and unencumbered assets see in detail: EBA, (2014), Guidelines on disclosure of encumbered and unencumbered assets, EBA/GL/2014/03, London, June 27. Encumbered assets are assets, most often on bank balance sheets. Encumbered assets are assets owned by a party but to which other parties hold legal or economic claims or liens. In many cases these encumbered assets cannot be sold until any outstanding debt or claims belonging to the owner of the assets are paid to the lender or claimholder who holds a claim or loan against or secured by these assets.

Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on the issue of covered bonds and covered bond public supervision and amending Directive 2009/65/EC and Directive 2014/59/EU, COM(2018) 94 final, 2018/0043 (COD), 12 March 2018; Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on amending Regulation (EU) No 575/2013 as regards exposures in the form of covered bonds, COM(2018) 93 final 2018/0042 (COD), 12 March 2018; EC, (2019), Press release IP/19/2130, of 18 April that the EP backed, among others, the covered bond proposals (also IP/19/1435 of 26 February 2019).

S. Aiyar et al., (2015), Revitalizing Securitization for Small and Medium-Sized Enterprises in Europe, IMF Staff Discussion Note, SDN/15/07, May, pp. 17–19.

There are already many official instruments available for SMEs and without material success so far; see: S. Aiyar et al., (2015), Revitalizing Securitization for Small and Medium-Sized Enterprises in Europe, IMF Staff Discussion Note, SDN/15/07, May, pp. 11–12.

Aiyar et al. propose a multifaceted strategy combining regulatory reforms and infrastructure development with targeted and time-bound official sector support to help revitalize the SME securitization market in Europe. This strategy involves (1) encouraging greater regulatory differentiation among securities of varying underlying asset quality and structures, (2) developing the right market infrastructure and facilitating cross-border investment through EU frameworks for harmonized credit reporting and insolvency regimes and (3) enhancing the scope of current EU initiatives for SME finance together with introducing a more nuanced treatment of SME-related collateral for refinancing with the Eurosystem. That could be complimented by a pan-European definition of high-quality securitization (HQS) comprising simple, transparent and efficient asset structures that can receive preferential regulatory treatment and official-sector support; see S. Aiyar et al., (2015), Revitalizing Securitization for Small and Medium-Sized Enterprises in Europe, IMF Staff Discussion Note, SDN/15/07, May, pp. 13–19.

D.J. Elliott, (2015), Capital Markets Union in Europe: Initial Impressions, Brookings Institute Research, February 23, via brookings.edu. He advances: ‘[g]ood market structures can aid banks and therefore indirectly help the SMEs, such as by facilitating securitization of SME loans. However, it will be important to ensure that banks retain a very considerable portion of the risk and reward from these loans, so that they will have sufficient incentives to do a good job of analyzing the credit risk of each loan and to intervene appropriately if necessary when things go wrong at the firms.’

Z. Darvas, (2013), Paper for European Parliament, Banking System Soundness is the Key to More SME, Bruegel, July, IP/A/ECON/NT/2013–02, mimeo.

See, for example, for an excellent study: A. Kara et al., (2015), Securitization and Lending standards: Evidence from the European Wholesale Loan Market, Board of Governors of the Federal Reserve System, International Finance Discussion Papers, Nr. 1141, August. See a contrario: T. Berg et al., (2015), Real Effects of Securitization, BAFFI CAREFIN Centre Research Paper Series Nr. 2015–14, June 8.

A. Kara et al., (2015), Securitization and Credit Quality, Board of Governors of the Federal Reserve System

International Finance Discussion Papers, Nr. 1148, November, Washington. See also Y. Wang, and H. Xia, (2015), Do Lenders Still Monitor When They Can Securitize Loans? Review of Financial Studies, Vol. 27, pp. 2354–2391.

A weakening of the bank’s screening incentives leads to weaker incentives for investors to become informed and a higher valuation uncertainty, creating a feedback effect that further weakens the bank’s screening incentives.

F. Cortes and A. Thokar, (2015), Does Securitization Increase Risk? A Theory of Loan Securitization, Reputation, and Credit Screening, Working Paper, December 5, mimeo.

M. Carney, (2014), Taking Shadow Banking out of the Shadows to Create Sustainable Market-Based Finance, Financial Times, June 16.

See in detail: E. Engelen & M. Aalbers, (2015), The Political Economy of the Rise, Fall and Rise Again of Securitization, Environment and Planning A, Vol. 47, Issue 8, pp. 1597–1605.

J. Kay, (2015), Other People’s Money. Master of the Universe or Servants of the People?, Profile Books, London.

S. Agarwal et al., (2015), Do Banks Pass Through Credit Expansion? The Marginal Profitability of Consumer Lending During the Great Recession, Working Paper, August 30, mimeo. That is in line with earlier research: A. Sufi, (2015), Out of Many, One? Household Debt, Redistribution and Monetary Policy During the Economic Slump, Andrew Crockett Memorial Lecture, BIS; J.B. Taylor, (2014), The Role of Policy in the Great Recession and the Weak Recovery, The American Economic Review, Vol. 104, Issue 5, pp. 61–66; C. Goodhart, (2015), Why Monetary Policy has been Comparatively Ineffective, The Manchester School, Vol. 83, pp. 20–29.

See for a comprehensive overview of the issues at hand: S. Aiyar et al., (2015), A Strategy for Resolving Europe’s Problem Loans, IMF Staff Discussion Note, September, SDN/15/19. Just before closing of the manuscript the first signs started to appear that levels of NPLs are on the decline, although with variation based on jurisdiction. EC, (2019), Banking Union: Non-performing loans in the EU continue to decline, Press Release IP/19/2932, June 12.

V. Bavoso, (2017), Capital Markets, Debt Finance and the EU Capital Markets Union: A Law and Finance Critique, ECMI Working Paper Nr. 5, October. See for a historical run-up to the CMU project pp. 1–4.

Bank-based financing models have their own detriments which have been discussed and which mainly revolved around cost of funding and availability of credit at any given time during the business cycle. See the discussion later in this book as well as V. Bavoso, (2017), ibid., pp. 4–6.

But even a market-based model is recurring allocation issues. Besides the living proof called the financial recession of 2007–2009 there are thematic issues that return at frequent intervals dealing with the question on how to finance evolution in industries. See, for example, EIB, (2018), Financing the Next Wave of Medical Breakthroughs – What Works and What Needs Fixing?, EIB Research Paper Nr. 2018/03, March; EIB, (2018), Financing the Deep Tech Revolution: How Investors Assess Risks in Key Enabling Technologies (KETs), EIB Research Paper Nr. 2018/02, March; A. Ferrando and C. Preuss, (2018), What Finance for What Investment? Survey-Based Evidence for European Companies, EIB Working Papers Nr. 2018/01, January; A. Ferrando and S. Ledpek, (2018), Access to Finance and Innovative Activity of EU Firms: A Cluster Analysis, EIB Working Paper Nr. 2018/02, January.

See in detail: SWBI-ESBG, (2015), Financial Systems in Europe and in the US: Structural Differences Where Banks Remain the Main Source of Finance for Companies, Working Paper, September (via wsbi-esbg.​org); S. Langfield and M. Pagano, (2015), Bank Bias in Europe: Effects on Systemic Risk and Growth, ECB Working Paper Series Nr. 1797, May; EIB, (2014), Unlocking Lending in Europe, EIB Working Paper Nr. 10/2014, in particular pp. 2–10. For the reasons why Europe experienced a negative growth rate of bank lending to nonfinancial corporations, see pp. 10–20; EIB, (2013) Investment and Investment Finance in Europe, EIB Working Paper Nr. 11/2013, in particular pp. 171–276; EIB, (2017) Investment and Investment Finance in Europe, EIB Working Paper Nr. 02/2017; J. Bats and A. Houben, (2017), Bank-Based Versus Market-Based Financing: Implications for Systemic Risk, DNB Working Paper Nr. 577, December.

See in detail: B. Braun, (2018), Central Banking and the Infrastructural Power of Finance: The Case of ECB Support for Repo and Securitization Markets, Socio-Economic Review, (published online February 20).

In detail: E. Gamberoni et al., (2016), Capital and Labour (Mis)allocation in the Euro Area: Some Stylized Facts and Determinants. ECB Working Paper Nr. 1981; G. Gopinath et al., (2017), Capital Allocation and Productivity in South Europe, Quarterly Journal of Economics, Vol. 132, Issue 4, pp. 1915–1967; Y. Gorodnichenko, et al. (2018), Resource (Mis)allocation in European Firms: The Role of Constraints, Firm Characteristics and Managerial Decisions, EIB Working Paper Luxembourg; F. Hassan et al., (2016), Bank Credit and Productivity Growth in the EU, EIB Working Paper Nr. 2016/05, December.

See, for example, M. Höpner and M. Lutter, (2018), The Diversity of Wage Regimes: Why the Eurozone Is Too Heterogeneous for the Euro, European Political Science Review, Vol. 10, Issue 1, pp. 71–96.

See recently F. W. Scharpf, (2017), Vom asymmetrischen Euro-Regime in die Transferunion – und was die deutsche Politik dagegen tun könnte, MPIfG Discussion Paper Nr. 17/15 Max-Planck-Institut für Gesellschaftsforschung, Köln, August. His earlier works on this matter can equally be recommended, just like the works on this matter of his colleague W. Streeck engaged with the same Max Planck Institute (www.​mpifg.​de).

See, for example, N. Anderson et al., (2015), A European Capital Markets Union: Implications for Growth and Stability, Bank of England Financial Stability Paper Nr. 33; C. Kaserer and M. Rapp, (2014), Capital Markets and Economic Growth – Long-Term Trends and Policy Challenges, Research Report, March (via europeanissuers.eu).

See for an analysis of capital market finance–related issues: V. Bavoso, (2017), Capital Markets, Debt Finance and the EU Capital Markets Union: A Law and Finance Critique, ECMI Working Paper Nr. 5, October, pp. 9–23. One of the elements he focuses on is the excessive debt creation in a market-based channel and why market-based channels lead to increases in leverage (pp. 14–19).

S. Cecchetti and E. Kharroubi, (2015), Why Does Financial Sector Growth Crowd Out Real Economic Growth?, BIS Working Paper Nr. 490, February; R. Sahay et al., (2015), Rethinking Financial Deepening: Stability and Growth in Emerging Markets, IMF Staff Discussion Note Nr. SDN/15/08, May. See the last chapter for an extensive coverage of this topic.

See the EC Factsheet: Delivering on the Capital Markets Union, 15 March 2019 via ec.​europe.​eu. See for updates on the progress of the project ec.europe.eu.

I will not argue each of the individual elements here as that is done throughout the two volumes of this book and in particular the last chapter of volume two.

See V. Bavoso, (2017), Capital Markets, Debt Finance and the EU Capital Markets Union: A Law and Finance Critique, ECMI Working Paper Nr. 5, October, pp. 6–9, for an overview of the arguments and analysis.

V. Bavoso, (2017), ibid., p. 31.

In many countries it took the respective economies more than ten years post-crisis to close the ‘output gap’ being the difference between actual and potential output levels of an economy. The CMU is claimed to offer the best available solution to the structural capacity gap in the area of macroeconomic stabilization. At least that I one view. The other points at the CMU as ‘a smokescreen to obscure a different, hidden policy agenda, namely the preferences of financial market actors’. See for that: B. Braun and M. Hübner, (2017), Fiscal Fault, Financial Fix? Capital Markets Union and the Quest for Macroeconomic Stabilization in the Euro Area, MPIfG Discussion Paper Nr. 17/21, Max-Planck-Institut für Gesellschaftsforschung, Köln, December, pp. 16–17. Regarding the dynamics of actual versus potential output gap see in particular: Ph. Heimberger and J. Kapeller, (2017), The Performativity of Potential Output: Pro-cyclicality and Path Dependency in Coordinating European Fiscal Policies, Review of International Political Economy, Vol. 24, Issue 5, pp. 904–928.

A. Turner, (2016), Between the Debt and the Devil, Princeton University Press, Princeton, NJ.

Geanakoplos discusses at length the detriments of a magnified credit cycle. See J. Geanakoplos, (2014), Leverage, Default and Forgiveness: Lessons from American and European Crises, Journal of Macroeconomics, Vol. 39, pp. 313–333. He reports eight reasons why credit cycles are bad for the underlying economy. That doesn’t seem to go hand in hand with the ambitions regarding sustainable finance as proclaimed. See Vice President Valdis Dombrovskis speech on sustainable finance at the European Parliament, Brussels, June 6, via ec.​europa.​eu).

B. Braun and M. Hübner, (2017), Fiscal Fault, Financial Fix? Capital Markets Union and the Quest for Macroeconomic Stabilization in the Euro Area, MPIfG Discussion Paper Nr. 17/21, Max-Planck-Institut für Gesellschaftsforschung, Köln, December. Also published in Competition and Change (2018), pp. 117–138.

A supranational fiscal capacity, which would be a key building block of a complete monetary union, remains out of reach due to diverging member state preferences and the complexities of the multilevel EMU governance regime. See B. Braun and M. Hübner, (2017), ibid., 16. Also see P. de Grauwe, (2017), The Limits of the Market: The Pendulum Between Government and Market, Oxford University Press, Oxford, p. 127. The result has been an institutionally ingrained, structural capacity gap that leaves the European polity—at both the national and the supranational levels—unable to provide the public good of macroeconomic stability.

The structural and instrumental power of finance in the European political process is well documented: D. Gabor, (2016), A Step Too Far? The European Financial Transactions Tax on Shadow Banking, Journal of European Public Policy, Vol. 23, Issue 6, pp. 925–945; C. Woll, (2016), Politics in the Interest of Capital: A Not-so-Organized Combat, Politics and Society, Vol. 44, Issue 3, pp. 373–391; K. Young et al., (2017), Capital United? Business Unity in Regulatory Politics and the Special Place of Finance, Regulation and Governance, Vol. 11, Issue 1, pp. 3–23; L. Kastner, (2017), Business Lobbying Under Salience: Financial Industry Mobilization Against the European Financial Transaction Tax, Journal of European Public Policy, published online August 9.

See B. Braun and M. Hübner, (2017), ibid., 16.

See B. Braun and M. Hübner, (2017), ibid., p. 17. They refer to the works of Quinn and Krippner regarding the US market and conclude that ‘the political power of finance appears deeply embedded in modern governmental strategies and technologies’. Managing the economy indirectly through market mechanisms follows a well-trodden path and not without alternatives as the EC often claims.

See B. Braun and M. Hübner, (2017), ibid., p. 18. Also see F. Fernandez and M.B. Aalbers, (2017), The Capital Market Union and Varieties of Residential Capitalism in Europe: Rescaling the Housing-Centred Model of Financialization, Finance and Society, Vol. 3, Issue 1, pp. 32–50.

See regarding the matter of the public-private partnership of money: K. Koddenbrock, (2017), What Money Does. An Inquiry Into the Backbone of Capitalist Political Economy, MPIfG Discussion Paper Nr. 17/9, Max-Planck-Institut für Gesellschaftsforschung, Köln, May. It includes a discussion on the role of capitalism as a perpetual model for ever-increasing profit and accumulation. Koddenbrock highlights: ‘[o]ur money-based capitalist political economy will always generate new money forms, greasing the machine of capital accumulation. Which importance these forms of money are allowed to gain and how complex they become depends on the willingness of the state to accommodate them, as money and moneyness continue to be public-private partnerships, driven largely by private profit desires’ (p. 19). ‘Capitalist money has entrenched a social distribution of power that is heavily skewed towards those who are able to create, mobilize, and control large swathes and chunks of money’ (p. 20). That public-private project has turned one-dimensional into a debt-laden economy and society. The sovereign is there simply to act as a backstop to ensure continued capital accumulation by a select group of private actors. See also on this matter: K. Judge, (2017), The Importance of Money: Book Review of The Money Problem: Rethinking Financial Regulation by Morgan Ricks, Harvard Law Review, Vol. 130, Issue 4, pp. 1148–1181; and in relation to shadow banking, see S. Murau, (2017), Shadow Money and the Public Money Supply: The Impact of the 2007–2009 Financial Crisis on the Monetary System, Review of International Political Economy, Vol. 15, Issue 4, pp. 1–37.

D. Camaradi, (2017), Will vs. Reason: The Populist and Technocratic Forms of Political Representation and Their Critique to Party Government, American Political Science Review, Vol. 111, Issue 1, pp. 54–67.

R.C. Hockett and S.T. Omarova, (2017), The Finance Franchise, Cornell Law Review Vol. 102, pp. 1143–1218; D. Mertens and M. Thiemann, (2017), Building a Hidden Investment State? The European Investment Bank, National Development Banks and European Economic Governance, Journal of European Public Policy, published online October 2; D. Mertens and M. Thiemann, (2018), Market-Based but State-Led: The Role of Public Development Banks in Stabilising Market-Based Finance in the European Union, Competition and Change, Vol. 22, Issue 2, pp. 184–204; M. Mazzucato and C.R. Penna, (2016), Beyond Market Failures: The Market Creating and Shaping Roles of State Investment Banks, Journal of Economic Policy Reform, Vol. 19, Issue 4, pp. 305–326; S. Griffith-Jones and G. Cozzi, (2017), The Roles of Development Banks: How They Can Promote Investment, in Europe and Globally, In Efficiency, Finance, and Varieties of Industrial Policy: Guiding Resources, Learning, and Technology for Sustained Growth, (eds.) Akbar Noman and Joseph Stiglitz, pp. 131–155, Columbia University Press, NY; P.A. Hall, (2018), Varieties of Capitalism in Light of the Euro Crisis, Journal of European Public Policy, Vol. 25, Issue 1, pp. 7–30.

H. Heclo, (1974), Modern Social Politics in Britain and Sweden, Yale University Press, New Haven.

See the last chapter of Vol. 2 of this book for a detailed analysis.

You sometimes wonder why brand-name research houses or consultancies are willing to lend their name to such studies. However, the expert-powered EU policymaking style provides ample opportunities for private sector actors to become involved and mobilize expert knowledge to advance their own interests. See, for example, J. Richardson, (2012), Supranational State Building in the European Union, in Constructing a Policy-Making State? Policy Dynamics in the EU, edited by J. Richardson, Oxford University Press, Oxford, pp. 3–28, p. 6.

R. Mayntz, (2018), Sovereign Nations and the Governance of International Finance, in J. Pixley and H. Flam (Eds.), Critical Junctures in Mobile Capital, Cambridge University Press, Cambridge, pp. 38–51.

L. Baccaro and C. Howell, (2017), Unhinged: Industrial Relations Liberalization and Capitalist Instability, MPIfG Discussion Paper Nr. 17/19, Max-Planck-Institut für Gesellschaftsforschung, Köln, November. A generalized liberalization trend in industrial relations, affected not just ‘liberal’ but also ‘coordinated’ forms of capitalism. They indicate, ‘liberalization has not taken place primarily through outright deregulation, but has involved alternative mechanisms that increase employer discretion without fundamentally altering the form of existing institutions.’

B. Braun et al., (2018), Governing Through Financial Markets: Towards a Critical Political Economy of Capital Markets Union, Competition and Change, Vol. 22, Issue 2, pp. 101–116.

B. Braun et al., (2018), ibid., in particular pp. 103–107.

First reported by Quinn in 2010: S. Quinn, (2010), Government Policy, Housing, and the Origins of Securitization, 1780–1968, PhD Thesis, University of California, Berkeley. Later reworked in S. Quinn, (2017), The Miracles of Bookkeeping: How Budget Politics Link Fiscal Policies and Financial Markets, American Journal of Sociology, Vol. 123, Issue 1, pp. 48–85.

G.R. Krippner, (2007), The Making of US Monetary Policy: Central Bank Transparency and the Neoliberal Dilemma, Theory and Society, Vol. 36, Issue 6, pp. 477–513, and later on more extensively G.R. Krippner, (2011), Capitalizing on Crisis: The Political Origins of the Rise of Finance, Harvard University Press, Cambridge, MA.

See, for example, recently S. Quinn, (2017), The Miracles of Bookkeeping: How Budget Politics Link Fiscal Policies and Financial Markets, American Journal of Sociology, Vol. 123, Issue 1, pp. 48–85.

The CMU project has enjoyed the intention and engagement of not only the EC but also financial sector associations, such as the Association for Financial Markets in Europe (AFME) or the European Banking Federation, were part of the CMU agenda-setting process via various consultations and other communication channels. Bruegel or the Centre for European Policy Studies (CEPS) can be added to that list, and many others.

See B. Braun et al., (2018), Governing Through Financial Markets: Towards a Critical Political Economy of Capital Markets Union, Competition and Change, Vol. 22, Issue 2, pp. 107–108, also for additional literature references.

N. Gadatsch et al., (2016), Thoughts on a Fiscal Union in EMU, Deutsche Bundesbank Discussion Paper Nr. 40, Frankfurt am Main.

A common argument for introducing a fiscal union often made in practice is that it alleviates the burden of (unjustifiably high) movements in risk premia (ibid., p. 19).

Ibid., p. 2, (‘[w]ith regard to welfare, it is possible to establish according to our simulations that the welfare gains that would materialize in a fiscal union are likely to be small’), pp. 17 ff.

See also G. Corsetti, et al., (2013), Sovereign Risk, Fiscal Policy, and Macroeconomic Stability, The Economic Journal, Vol. 123, F99–F132; M.P. Evers, (2015), Fiscal Federalism and Monetary Unions: A Quantitative

Assessment, Journal of International Economics, Vol. 97, pp. 59–75; N. Gadatsch, et al., (2016), Fiscal Policy During the Crisis: A Look on Germany and the Rest of the Euro Area with GEAR, Economic Modelling, Vol. 52, pp. 997–1016.

ECB, (2015), Report on Financial Structures, October, p. 46. See also the more recent reports ECB, (2017), Report on Financial Structures, October.

See also ECB, (2015), Financial Stability Review, Structural Features of the Wider Euro Area Financial System, May pp. 87–99.

See in detail ECB, (2015), Report on Financial Structures, October, ibid., p. 47.

ECB, (2015), ibid., p. 47.

ECB, (2015), ibid., p. 48.

See ECB, (2017), Report on Financial Structures, October, pp. 6–21.

ECB, (2015), ibid., pp. 49–50.

ECB, (2015), ibid., p. 52. Also see ECB, (2017), ibid., pp. 22–44.

ECB, (2015), ibid., pp. 53–54. Also see ECB, (2017), ibid., pp. 56–65, passim.

Those countries not mentioned in the list have no specifics going on their shadow banking markets. General data regarding those markets (and those markets discussed) can be retrieved through the annual FSB global shadow banking monitoring report and the bi-annual ECB financial stability report, as well as through the domestic financial stability reports of their respective central banks. For statistics I can refer to the already discussed annual FSB global shadow banking/nonbank financial intermediation reporting, via fsb.​org.

See J. Keller, (2012), NBB Financial Stability Report: The Shadow Banking System: Economic Characteristics and Regulatory Issues, pp. 120–134, in particular p. 128.

Updated volumes to be consulted via the bi-annual EU’s Financial Stability Reports and the National Bank of Belgium.

ECB, (2015), Financial Stability Review 2014, Frankfurt, May, pp. 98, passim.

Other than regulatory threats for Belgium are listed in CSFI, (2014), Banking Banana Skins 2014. Inching Towards Recovery, New York; see also: M. Chang and E. Jones, (2014), Belgium and the Netherlands: Impatient Capital Market-Based Banking and the International Financial Crisis (eds.) by I. Hardie and D. Howarth, Oxford University Press, Oxford, pp. 79–10, and in particular pp. 86–87. They indicate that both Belgian and Dutch banks were most exposed to foreign shadow banking products which were allowed to issue more credit than would be allowed had they been forced to list them on their balance sheets. Belgium and the Netherlands were the most exposed countries in Europe measured against their GDP during or before the 2008 crisis.

NBB, (2015), Financial Stability Review, June, pp. 40–42 (also for a breakdown).

NBB, (2015), Financial Stability Review, June, p. 24.

Ibid., pp. 11–12.

See also fragmented in the Report of the High Level Expert Group Established on the Initiative of the Minister of Finance of Belgium, (2016), The Future of the Belgian Financial Sector, January 13.

NBB, (2017), Report on Asset Management and Shadow Banking, September, via nbb.be., with an update in September 2018, via nbb.be. The SB sector represents approximately EUR 147 billion.

M. Druant and S. Cappoen, (2017), Belgian Shadow Banking Sector with a Focus on OFIs, Paper for the IFC-NBB Workshop ‘Data needs and statistics compilation for macroprudential analysis’ (18–19 May 2017), via bis.​org

NBB, (2019), Financial Stability Report 2019, June, Section 6.2, pp. 36–40; NBB, (2018), Financial Stability Report, June, Section 2.4, pp. 29–31.

See B. Godfrey and B. Golden, (2012), Measuring Shadow Banking in Ireland Using Granular Data, Central Bank Quarterly Bulletin, Nr. 4, pp. 82–96 and B. Godfrey and C. Jackson, (2011), Meeting the Statistical Challenges of Financial Innovation: Introducing New Data on Securitisation, Central Bank Quarterly Bulletin Q3, pp. 109–122.

See B. Godfrey et al., (2015), Data gaps and Shadow Banking: Profiling Special Purpose Vehicles’ Activities in Ireland, Central bank Quarterly Bulletin, Nr. 3, pp. 48–60 (particularly interesting are the technical features of the vehicles discussed in 4.1 [pp. 52 ff.]: they include the use of ‘limited recourse’ and ‘non-petition’ covenants within the legal contracts. ‘Limited recourse’ means that creditors of the vehicle only have a claim on what the entity is paid. ‘Non-petition’ refers to a situation whereby creditors give up the right to petition for liquidation of the vehicle. Many of the contracts underpinning the incorporation and activities of these vehicles are governed by UK or US law even though the entities are registered in Ireland. See also the case studies pp. 54 ff.); also see Central Bank of Ireland (2014), Box 6: Monitoring FVC and SPV Activity in Ireland, Macro-Financial Review, p. 39, December.

B. Godfrey et al., (2015), ibid., p. 59.

Ireland Central Bank, (2015), Financing Developments in the Irish Economy, CB Quarterly Bulletin Q4, pp. 37–45, in particular pp. 42–45.

That is based on the five-category methodology as developed by the FSB in 2013 and applied in their analysis since their 2015 global shadow banking monitoring report.

See extensively: FSB, (2015), Global Shadow Banking Monitoring Report, Annex 2, pp. 48–52.

Sellable means that an asset can be disposed of at a price within 10% of its current market price.

FSB, (2015), Global Shadow Banking Monitoring Report, Annex 2, pp. 50–52.

B. Golden and E. Maqui, (2018), Shadow Banking Risk in Non-securitization SPEs, CBI Economic Letter, Nr. 12, via centralbank.ie; CBI, (2018), Macro-Financial Review 2019, II, pp. 55.

D. O’Donovan, (2018), Irish Shadow Banking Dwarfs More Traditional Sectors, Independent, March 6, via independent.ie.

Bank of Italy, (2015), Lo shadow banking e la regolamentazione italiana, Intervento di Carmelo Barbagallo Capo del Dipartimento Vigilanza Bancaria e Finanziaria Banca d’Italia, NIFA – New International Finance Association World Finance Forum 2015 ‘La rinascita economica e finanziaria in Europa e in Italia’, Milan, March 5.

C. Barbagallo, (2015), Shadow Banking and Italian Regulation, Italy, p. 24. See also their official feedback to the EC green paper on shadow banking: ABI, (2012), ABI Response to the Commission Green Paper on Shadow Banking, Associazione Bancaria Italiana, Milan.

ECB, (2015), ibid., pp. 98, passim

G. Nuzzi, (2017), A Critical Review of the Statistics on the Size and Riskiness of the Securitization Market: Evidence from Italy and other Euro-Area Countries, Bank of Italia Working Paper Nr. 403, October.

L.F. Signorini, (2018), The Regulation of Non-Bank Finance: the Challenges Ahead, Speech by Deputy Governor of the Bank of Italy L. F. Signorini, November 16, via bancaditalia.it. Also: C. Gola et al., (2017), Shadow Banking out of the Shadows: Non-Bank Intermediation and the Italian Regulatory Framework, Bank of Italy Occasional paper Series Nr. 372, February.

LLB, (2013), Financial Stability Review, Vilnius, p. 9.

There is one good paper providing a recent overview: M. Hodula, (2018), Off the Radar: Exploring the Rise of Shadow Banking in the EU, Czech National Bank Working Papers Nr. 2018/16.

See for an introductory article regarding shadow banking in Russia: P. Vishnevskiy, (2015), Regulating Shadow banking in Russia: Brief Overview, International Journal for Financial Services. Nr. 3, pp. 26–32. His analysis includes broker and dealer activities, activities of special purpose vehicles, micro-finance companies, investment funds and non-state pension funds as well pawnshops; A. Ponomarenko, (2016), A Note on Money Creation in Emerging Market Economies, Bank of Russia Working Paper Nr. 10, May.

D. Hansson et al., (2014), Shadow Banking from a Swedish Perspective, Sveriges Riksbank Economic Review, Issue 3, Stockholm, p. 34.

D. Hansson et al., (2014), ibid., p. 37.

D. Hansson et al., (2014), ibid., p. 38. Also more recent: R. Portes, (2018), Interconnectedness; Mapping the Shadow Banking Sector, Ademu Working Paper Nr. 117, April, via ademu-project.eu, p. 4; J. Abad, (2018), Mapping the Interconnectedness between EU Banks and Shadow Banking Entities, Ademu Working Paper Nr. 114, April, via ademu-project.eu.

M. Sandström, (2013), The Swedish Covered Bond Market and Links to Financial Stability, Sveriges Riksbank

Economic Review, Issue 2, Sveriges Riksbank, Stockholm, pp. 22–49. Covered bonds are characterized by increased safety for the investor by a claim both on the issuer and on an underlying cover pool.

P. Jackson, (2013), Shadow Banking and New Lending Channels—Past and Future, in 50 Years of Money and Finance: Lessons and Challenges, M. Balling and E. Gnan (eds.), SUERF/Larcier, Vienna, p. 391.

J. Keller, et al., (2014), Securities Financing Transactions and the (Re)use of Collateral in Europe – An analysis of the first data collection conducted by the ESRB from a sample of European banks and agent lenders, ESRB Occasional Paper Series, Nr. 6 (September), European Systemic Risk Board; D. Hansson et al., (2014), ibid., pp. 39–43.

D. Hansson et al., (2014), ibid., p. 48. Also: B. Wilhelm, (2018), Shadow Banking, in J. Tae-Hee and L. Chester, C. D’Ippoliti (eds.) The Routledge Handbook of Heterodox Economics. Theorizing, Analyzing, and Transforming Capitalism, London: Routledge, pp. 264–275.

Germany sees no rise in systemic risk coming from their shadow banking sector. The weight of the German shadow banking industry has grown in recent years relative to the rest of Germany‘s financial system. Germany‘s shadow banking actors are generally regulated entities such as mutual funds. Maturity and liquidity transformation stable and leverage on the decline in the system; see: Deutsche Bundesbank, (2015), Financial Stability Review, November 25, p. 10. The German shadow banking system is considered small but globally connected: Deutsche Bundesbank, (2012), Financial Stability Review 2012, pp. 67–78. More broadly: Deutsche Bundesbank, (2014), The Shadow Banking System in the Euro Area: Overview and Monetary Policy Implications, Monthly Report, March, pp. 15–34; O. Kessler and B. Wilhelm, (2017), Shadow Banking and the Question of Political Order, in: Anastasia Nesvetailova (ed.) Shadow Banking. Scope, Origins and Theories. Abingdon: Routledge, pp. 54–71. In 2018 about a third of the over 1 trillion in managed assets, about one-third were SB denominated assets. See: DBD, (2018), Deutsche Bundesbank Financial Stability Report 2018, pp. 100–102.

See for details: ECB, (2015), Financial Stability Review 2014, Frankfurt, pp. 88, 91, 98, passim.

M. Charrell, (2013), La finance del’ombre représente toujours un énorme risqué systémique, Le Monde, September 15–16; L. Scialom and Y. Tadjeddine, (2014), Banque hybride et réglementation des banques de l’ombre, Working Paper, November 14; E. Jeffers and D. Phihon, (2014), Le shadow banking system et la crise financière, Cahiers français Nr. 375, pp. 50–57, Paris, La Documentation française; D. Plihon, (2010), La réforme de la régulation financière, Cahiers français Nr. 359, novembre-décembre.

FSB, (2019), Global Monitoring Report on Non-nank Financial Intermediation 2018, pp. 13, 19.

ECB, (2015), ibid., p. 98. Also: C. Duclos and R. Morhs, (2017), Analysis on the Shadow Banking Context of Captive Financial Companies in Luxembourg, Working Document, Comité du Risque Systémique, April.

This remains their largest market; FSB, (2019), ibid., p. 14.

See in detail: Bank of England, (2014), Financial Stability Review, June Nr. 35, pp. 73–76.

Bank of England, (2015), Financial Stability Review, July Nr. 37, pp. 46–47.

Bank of England, (2014), Financial Stability Review, December Nr. 36, pp. 40–42.

C. Giles, C. Binham and M. Arnold, (2015), Bank of England Draws Line Under Bank-Bashing, Financial Times, December 1.

Bank of England, (2015), Financial Stability Review, December, Nr. 38, pp. 51–54.

Bank of England, (2018), Financial Stability Review, November, Nr. 44, pp. 51–57.

Study conducted as a cooperation between the Financial Stability Board and the Swiss National Bank in collaboration with the SNB’s Statistics and International Monetary Relations units, as well as the Federal Department of Finance and the Swiss Financial Market Supervisory Authority, FINMA.

T.K. Birrer et al., (2019), Unternehmensfinanzierung mit Private Debt in der Schweiz, Lucern University Report. Also see SNB, (2018), Financial Stability Report, pp. pp. 22–23. Also infra special report on Switzerland under 13.15.4

About 760% of GDP compared to 348% (UK) and 261% (Switzerland); FSB, (2014), Global Shadow Banking Monitoring Report, Basel, p. 11.

FSB, (2014), Global Shadow Banking Monitoring Report 2014, p. 7.

FSB, (2014), Global Shadow Banking Monitoring Report 2014, p. 11. Elsewhere the FSB reports; ‘In the case of the Netherlands, Special Financial Institutions (SFIs) dominate the OFI sector (they accounted for 68% of the OFI assets in 2013). About 80% of the Dutch SFIs are part of non-financial groups which are not involved in credit intermediation outside of the group. These non-financial SFIs therefore do not fall within the FSB’s shadow banking definition and were excluded in the narrow measure of shadow banking’ (pp. 21–22).

FSB, (2014), Global Shadow Banking Monitoring Report 2014, p. 26.

More recently the growth of BFIs is on the decline (in capital terms): DNB, (2014), Groei BFI’s neemt af in 2013, Statistisch Nieuwsbericht, 29 December 2014, www.​dnb.​nl. One-third of them are linked to US MNCs and increasingly linked to emerging market MNCs.

DNB (M. Broos et al.), (2012), Shadow Banking: An Exploratory Study for the Netherlands, DNB Occasional Studies, Vol. 10 Nr. 5, p. 24; see also D. Bezemer and J. Muyskens, (2015), Dutch Financial Fragilities, WRR Working Paper Nr. 13, November.

De Nederlandsche Bank (DNB), (2012), Nederlandse banken en buitenland grootste bezitters van Nederlandse securitisaties, Statistisch Nieuwsbericht, 24 April 2012, www.​dnb.​nl

See the study of Den Boer who explored the Dutch National Accounts in search for some answers regarding the size and nature of the Dutch shadow banking market, P. den Boer, (2016), Shadow Banking in the Dutch National Accounts, Paper prepared for the 34th IARIW General Conference, via iariw.​org

DNB, (2012), ibid., p. 27.

De Nederlandsche Bank (DNB), 2008, Nederland nog steeds aantrekkelijk voor BFI’s, Statistisch Bulletin, September pp. 21–24, www.​dnb.​nl. See for a historical write-up: De Nederlandsche Bank (DNB), 2000, Bijzondere financiële instellingen in Nederland, Statistisch Bulletin, March, pp. 19–27, www.​dnb.​nl

OECD, (2013): ‘[in] general terms SPEs are entities with no or few employees, little or no physical presence in the host economy, whose assets and liabilities represent investments in or from other countries, and whose core business consists of group financing or holding activities.’

DNB, (2012), ibid., p. 28.

DNB, (2012), ibid., p. 30.

The other part is not involved in (credit, liquidity or maturity) transformation.

DNB, (2012), ibid., p. 31.

DNB, (2012), ibid., p. 33.

DNB, (2012), ibid., p. 33.

DNB, (2012), ibid., p. 34.

See also: R. Fernandez and E. Engelen, (2014), Shadow Banking and Offshore Finance: The Role of the Netherlands, Working Paper, pp. 9–20; E. Engelen, (2017), Shadow Banking After the Crisis: The Dutch Case, Theory, Culture and Society, Vol. 34, Issue 5–6, pp. 53–75.

See for analysis and detail: A. Lejour et al., (2019), Dutch Shell Companies and International Tax Planning, CPB Discussion Paper, June 26 via cpb.nl. See also their policy brief on the matter earlier in the year: A. Lejour et al., (2019), Doorsluisland NL doorgelicht, CPB Policy Brief, January.

D. Bezemer and J. Muysken, (2015), Dutch Financial Fragilities, Working Paper, April 15.

DNBulletin, (2012), Dutch Shadow Banking Sector Smaller Than It Seems at First Sight, De Nederlandsche Bank, 29 November. See for recent data FSB, (2019), ibid., pp. 14, 18–20, 25.

In contrast to section 3.15.3 this section deals exclusively with the Swis SB position in the context of the FSB analysis in their global annual write-up.

See FSB, (2014), Global Shadow Banking Monitoring Report, Exhibit A2–1, p. 31.

See FSB, (2014), Global Shadow Banking Monitoring Report, pp. 32–33.

See FSB, (2014), Global Shadow Banking Monitoring Report, pp. 33–34.

These five activities, as already discussed, are (1) management of collective investment vehicles, (2) loan provision that is dependent on short-term funding, (3) intermediation of market activities that is dependent on short-term funding or on secured funding of client assets, (4) facilitation of credit creation and (5) securitization and securitization-based credit intermediation and funding of financial activities. That categorization is based on the criteria as set out by the FSB; see in detail: FSB, (2013), Policy Framework for Strengthening Oversight and Regulation of Shadow Banking Entities, pp. 6–11.

See in detail: L. Grillet-Aubert et al., (2016), Assessing Shadow Banking—Non-Bank Financial Intermediation in Europe, ESBR Report Nr. 10, July, Table 2, pp. 6 ff and Annex 2 (p. 50). It should be noted, however, that although standardization is attempted across supervisors and regulators, each body uses their own set of criteria which might or might not look (relatively) similar to this one.

See in detail: C. Girón and A. Matas, (2017), Interconnectedness of Shadow Banks in the Euro Area, IFC-National Bank of Belgium Workshop on ‘Data Needs and Statistics Compilation for Macroprudential Analysis’, 18–19 May 2017. They use the already discussed network centrality concept, eigenvector centrality, to provide a euro area cross-country comparison of interconnectedness of shadow banks with the rest of the economy. By using eigenvector centrality they capture direct and indirect financial connection paths between sectors (p. 21).

See: ESBR, (2016), EU Shadow Banking Monitor, Nr. 1, July; ESBR, (2017), EU Shadow Banking Monitor, Nr. 2, May. For assessment year 2016 (report 2017) it was highlighted that ‘[t]he increasing size of the EU investment fund sector as a proportion of the financial system, coupled with the liquidity transformation and leverage present in some investment funds’ business models, can amplify financial stability risks’. Honesty forces me to acknowledge that the ‘can amplify financial stability risks’ argument is used for the levels of leverage measured, the buildup of synthetic leverage , parts of the SB space that fall outside the currently applied perimeters and certain types of interconnectedness identified. Passe-partout statement, however, reduces the usefulness of the analysis (p. 2); ESBR, (2018), EU Shadow Banking Monitor, Nr. 3, September 10, Frankfurt am Main. The size of the EU shadow banking system was little changed in 2017, with total assets of just over EUR 42 trillion. European banks remain highly interconnected with the shadow banking system by providing funding to entities engaged in shadow banking activities. Interconnectedness, in the form of wholesale funding provided to euro area banks by entities included in the shadow banking measure, has increased, following a period of contraction. EU bond funds, for example, have increased their liquidity transformation, credit and interest rate risk-taking activities in recent years. See for a review of the different shadow banking components in Europe: L. Grillet-Aubert et al., (2016), Assessing Shadow Banking—Non-Bank Financial Intermediation in Europe, ESBR Report Nr. 10, July. They use both an entity- and activity-based approach (dual approach), due to the fact that it yields a more comprehensive overview (both off- and on-balance sheet analysis) and a deeper understanding of the structural vulnerabilities of any shadow banking system.

ECB, (2016), Financial Stability Review, May, pp. 12, 91 ff.

See E. Jeffers and D. Plihon, (2016), What Is So Special European Shadow Banking, FEPS Studies, August.

See for extensive coverage: L. Grillet-Aubert et al., (2016), Assessing Shadow Banking—Non-Bank Financial Intermediation in Europe, ESBR Working Paper Nr. 10, July.

Ibid., pp. 40–41.

ECB, (2019), Financial Stability Review, May, p. 97.

See ECB, (2019), Financial Stability Review, May, pp. 97–110, for details and number support.

R. Heuver and R. Triepels, (2019), Liquidity Stress Detection in the European Banking Sector, DNB Working Paper Nr. 642, June 28. The focus on the aspect of machine learning is helping the central banks to conduct (liquidity) stress tests, by using certain classifiers.

ECB, (2018), Financial Stability Review, November, pp. 31–32, passim; ECB, (2018), Financial Stability Review, May, pp. 113–129.

CGFS, (2017), Repo Market Functioning, CGFS Papers Nr. 59, Committee on the Global Financial System, Bank for International Settlements, April, via bis.​org

ECB, (2017), Financial Stability Review, May, pp. 158–174; ECB, (2016), Financial Stability Review, November, pp. 134–146.

EBA, (2019), Draft Guidelines on Loan Originating and Monitoring, Consultation Paper, EBA/CP/2019/04, June 19, via eba.​europe.​eu. The draft Guidelines specify the internal governance arrangements for granting and monitoring of credit facilities throughout their lifecycle. They introduce requirements for borrowers’ creditworthiness assessment and bring together the EBA’s prudential and consumer protection objectives. The EBA has developed these Guidelines building on the existing national experiences, addressing shortcomings in the institutions’ credit granting policies and practices highlighted by the recent financial crisis. At the same time, these Guidelines reflect recent supervisory priorities and policy developments related to credit granting.

ESRB, (2018), EU Shadow Banking Monitor Nr. 3, September, via esrb.​europa.​eu

C. Guagliano et al., (2019), Use of Credit Default Swaps by UCITS Funds: Evidence from EU Regulatory Data, ESRB Working Paper 95, June 17.

See for the issue(s) in general: V. Acharya, et al. (2016), ‘Lender of Last Resort Versus Buyer of Last

Resort – The Impact of the European Central Bank Actions on the Bank-Sovereign Nexus’, ZEW Discussion Paper, Nr. 19; C. Altavilla, et al., (2016), Bank Exposures and Sovereign Stress Transmission, ESRB Working Paper, Nr. 11, May; R.J. Barro, and A. Mollerus, (2014), Safe Assets, NBER Working Paper, Nr. 20652,

October; R. Beck, et al., (2016), Determinants of Subsovereign Bond Yield Spreads: The Role of Fiscal Fundamentals and Federal Bailout Expectations, ECB Working Paper, Nr. 1987, December; M. Brunnermeyer et al., (2016), The Sovereign-Bank Diabolic Loop and ESBies, American Economic Review: Papers and Proceedings, Vol. 106, Nr. 5, pp. 508–512; R.J. Caballero et al., (2016), Safe Asset Scarcity and Aggregate Demand, American Economic Review: Papers and Proceedings, Vol. 106, Nr. 5, pp. 513–518; Deutsche Bundesbank (2016), Approaches to Resolving Sovereign Debt Crises in the Euro Area, Monthly Report, July, pp. 41–62; A. Gelpern and E.F. Gerding, (2016), Rethinking the Law in ‘Safe Assets’, Chapter 9 in R.P. Buckley, E. Avgouleas and D.W. Arner (eds.), Reconceptualising Global Finance and Its Regulation, Cambridge University Press, New York, pp. 159–189; G.B. Gorton, (2016), The History and Economics of Safe Assets, NBER Working Paper, Nr. 22210, April; P.-O. Gourinchas, and H. Rey, (2016), Real Interest Rates, Imbalances and the Curse of Regional Safe Asset Providers at the Zero Lower Bound, NBER Working Paper Nr. 22618, September; R.J. Caballero, (2016), Safe Asset Scarcity and Aggregate Demand, American Economic Review, Vol. 106, Issue 5, pp. 513–518.

See regarding the nature of safe assets: A. van Riet, (2017), Addressing the Safety Trilemma: A Safe Sovereign Asset For the Eurozone, ESRB Working Paper Series, Nr. 35, pp. 6–12; Z. He et al., (2016), What Makes US Government Bonds Safe Assets?, American Economic Review: Papers and Proceedings 2016, Vol. 106, Nr. 5, pp. 519–523; Z. He, et al., (2016), A Model of Safe Asset Determination, NBER Working Paper, Nr. 22272, May; A. Gelpern and E.F. Gerding, (2016), Inside Safe Assets, Yale Journal on Regulation, Vol. 3, Issue 2, pp. 363–421; also as Georgetown University Law Center Working Paper, September 26, pp. 10–24.

The rising demand for money-like claims is considered the main driver behind the growth of the shadow banking segment pre-crisis. The supply of T-bonds and T-bills was not only no longer sufficient, there is also a benefit for the financial intermediaries through the money premium when they issue certain types of low-risk, short-term debt, such as asset-backed commercial paper or repo. An interesting question in this context is, given the demand for safe assets as a fixed element, how central banks can improve financial stability and manage maturity transformation by the private sector through their ability to affect the public supply of short-term safe instruments (STSI). Carlson et al. provide some insights into this and conclude that ‘increasing the supply of public STSI reduces the attractiveness of private STSI, and thus potentially helps improve the stability of the financial system’ (p. 15). Private and public STSI are substitutes, ‘so that greater provision of STSI by a central bank, for example, through reverse repurchase agreements, could meet the demand for STSI and help crowd out creation of private STSI’. The precise extent to which an increase in public STSI would crowd out private STSI remains uncertain until now. See in detail: M. Carlson et al., (2014), The Demand for Short-Term, Safe Assets and Financial Stability: Some Evidence and Implications for Central Bank Policies, Finance and Economics Discussion Series (Nr. 102), Divisions of Research & Statistics and Monetary Affairs Federal Reserve Board, Washington, DC, November 25.

P. de Grauwe and Y. Ji, (2018), How Safe Is a Safe Asset, CEPS Policy Insight, Nr. 2018–08, February (via ceps.eu), and P. de Grauwe and Y. Ji, (2018), Financial Engineering Will Not Stabilize an Unstable Euro Area, March 19 (via voxeu.​org).

A. Bénassy-Quéré, et al., (2018), Reconciling Risk Sharing with Market Discipline: A Constructive Approach to Euro Area Reform, CEPR Policy Insight, Nr. 91, January.

European Systemic Risk Board (ESRB), (2018), Sovereign Bond-Backed Securities: A Feasibility Study, ESRB High-Level Task Force on Safe Assets, January, Vol. I and II. It actually all started with a speech given by B. Coeuré in 2016: B. Coeuré, (2016), Sovereign Debt in the Euro Area: Too Safe or Too Risky? Keynote Address Harvard University’s Minda de Gunzburg Center for European Studies in Cambridge, MA, November 3.

See in detail D. Gabor and J. Vestergaard, (2018), Chasing Unicorns: The European Single Safe Asset Project, Competition and Change, Vol. 22, Issue 2 pp. 140–164. Also abbreviated on the topic: D. Gabor, (2018), The Single Safe Asset: A Progressive View for a ‘First Best EMU’, FEPS Policy Brief, May.

D. Gabor and J. Vestergaard, (2018), ibid.

P. De Grauwe and Y. Ji, (2013), Self-fulfilling Crises in the Eurozone: An Empirical Test, Journal of International Money and Finance, Vol. 34, April, pp. 15–36.

When issued in their own currency they also have their own national bank that can step in and provide liquidity to repay investors at maturity date. See about the safe haven of currencies: K.-S. Lee, (2017), Safe-Haven Currency, Review of International Economics, Vol. 25, Issue 4, pp. 924–947. He concludes that only the Swiss franc and the Japanese yen qualify as safe. The others are ‘equity-like’ or risky positive related to risky assets and even more so in times of crisis.

Often during recessions. See also M. Bichuch and P. Guasoni, (2018), Investing with Liquid and Illiquid Assets, Mathematical Finance, Vol. 28, Issue 1, pp. 119–152. Hartmann studies different dimensions of (international) liquidity. He concludes that financial regulation in this matter needs to be designed in a way that preserves incentives for market making in major international assets. See Ph. Hartmann, (2018), International Liquidity, CEPR Discussion Paper Nr. DP12337, October. Also see R. Lagos et al., (2017), Liquidity: A New Monetarist Perspective, Journal of Economic Literature, Vol. 55, Issue 2, pp. 371–440.

This model needs to be seen as distinct to the model earlier suggested where Eurobonds would be created. In that model the participating governments are jointly liable for servicing the (national) debt issued. In the ESRB model there is no ‘joint liability element’, and so no pooling of risk. The only thing that happens is the repackaging of a set of diverse (i.e. issued by different countries) Eurobonds that are bundled and offered to the market.

Often separated in two classes: the junior tranche (mot risky) and the mezzanine tranche (less but still risky).

For example, larger than in case each country individually issues national debt in euro-terms. The ESRB believes it could actually double the volumes of safe eurozone assets.

Also see P. de Grauwe and Y. Ji, (2018), How Safe is a Safe Asset, CEPS Policy Insight, Nr. 2018–08, February, pp. 2–4 (via ceps.eu).

European Systemic Risk Board (ESRB), (2018), Sovereign Bond-Backed Securities: A Feasibility Study, January, p. 33. The ESRB assumed one-third of total bond stock would be eligible for SBBS. Also see M. Brunnermeier, et al., (2016), ESBies: Safety in the tranches, ESRB Working Paper Series, Nr. 21.

Brunnermeier and Huang have taken it a notch up and have examined international capital flows induced by flight-to-safety. They suggest a new global safe asset. In a variety of scenarios they demonstrate that it can reduce the severity of a crisis and alternatively capital flows are re-channeled from international cross-border flows to flows across two emerging market economy asset classes. See in detail: M. K. Brunnermeier and L. Huang, (2018), A Global Safe Asset for and from Emerging market Economies, NBER Working Paper Nr. 25373, December. Le Grand and Ragot are thinking along the same line, and recommend that a world fund issuing a safe asset increases aggregate welfare. Those assets can be related with the existing International Monetary Fund (IMF) American Depository Receipts (ADRs). See in detail F. Le Grand and X. Ragot, (2018), Sovereign Default and Liquidity: The Case for a World Safe Asset, Working Paper, September 7, mimeo.

See the already discussed: B. Holmström, (2015), Understanding the Role of Debt in the Financial System, BIS Working Paper, Nr. 479, January.

It is a much stronger force of nature than a stylized model that demonstrates that a union-wide safe asset without joint liability would resolve capital flight dislocations and marketplace instability as well as the fact that diversification and seniority can weaken the loop between sovereign and bank risk; see: M. K. Brunnermeier, et al., (2017). ESBies: Safety in the Tranches. Economic Policy, Vol. 32, Issue 90, pp. 175–219; C. Buch, (2016), Banks and Sovereign Risk: A Granular View, Journal of Financial Stability, Vol. 25, pp. 1–15; E. Farhi and J. Tirole, (2016), Deadly Embrace: Sovereign and Financial Balance Sheets Doom Loops, NBER Working Paper Nr. 21843.

See J.C. Lopez et al., (2013), The Market for Collateral: The Potential Impact of Financial Regulation, Financial Stability Review, June, pp. 45–53. M. Carlson et al., (2016), The Demand for Short-Term, Safe Assets and Financial Stability: Some Evidence and Implications for Central Bank Policies, International Journal of Central Banking, Vol. 12, Issue 4, pp. 307–333; R. Greenwood et al., (2016), The Federal Reserve’s Balance Sheet as a Financial Stability Tool, Harvard Business School Paper, September, mimeo.

See in detail the already discussed: A. Antoniadis and N. Tarashev, (2014), Securitizations: Tranching Concentrates Uncertainty, BIS Quarterly Review, December, pp. 37–53; A. Persaud, (2015), The Assets Made Combustible When Regulators Call Them ‘Safe’, Financial Times, June 2.

Correlation can only be assumed to be fixed; in case they go random which they do under stress, the model goes idle; see also M. Brunnermeier, et al. (2017), ESBies: Safety in the tranches, Economic Policy, Vol. 32, Issue 90, pp. 175–219 (also in ESRB Working Paper Series 2016, Nr. 21).

That information-sensitivity will look deeply problematic in the face of all the issues still surrounding the rating of an SBBS product. See M. Kraemer, (2017), How S&P Global Ratings Would Assess European ‘Safe’ Bonds (ESBies), S&P Global Ratings, April 25.

The impression is that the process is organized backward. There is a large unmet need for safe assets in the eurozone. That need becomes pressing in times of market stress. With political reality in mind, an artefact is constructed obeying that political reality, but which ignores market characterizations in times of distress. A combination of pooling and tranching provides better results than either of these two separately, but that was not the question; in fact it never has been the question. The junior tranche would have risk characteristics and embedded leverage that would be attractive to high-yield investors (M. Brunnermeier, et al. [2017], ibid., p. 36) points exactly at the problem. The attractiveness of high-yield investor wanes overnight in times of distress, aggravating the dislocation caused by capital flight. ESBies would then insulate senior bondholders from actual default risk; the dislocation and contamination would then come from the junior or mezzanine tranches. But spillover effects seem to fall in general during market stress; see D. Cronin and P.G. Dunne, (2018), How Effective are Sovereign Bond-Backed Securities as a Spillover Prevention Device?, ESBR Working Paper Series Nr. 66, January. See regarding the constituent elements of the bid-ask spread: B. Hagströmer et al., (2016), Components of the Bid–Ask Spread and Variance: A Unified Approach, Journal of Futures Markets, Vol. 36, Issue 6, pp. 545–563.

M. de Sola Perea et al., (2018), Sovereign Bond-Backed Securities: A VAR-for-VaR and Marginal Expected Shortfall Assessment, ESRB Working Paper Series Nr. 65, January. They use a combination of VAR-for-VaR and MES models to arrive at their conclusions. Earlier models were based on simulated default outcomes—based on a variety of assumed probabilities of defaults, default correlations and expected losses given defaults—rather than on the losses that arise from fluctuations in the market valuation of the securities. The VAR-for-VaR reveals how the likelihood of extreme outcomes in one asset relates to another given some causal ordering. The MES, in contrast, reveals how one asset is expected to fare in terms of expected return when another asset is likely to be experiencing a tail event. MES can therefore capture flight-to-safety dynamics (i.e. a positive outcome when a riskier asset is expected to be experiencing an extremely negative outcome) (pp. 1–2). P. Gao, et al., (2017), Liquidity in a Market for Unique Assets: Specified Pool and To-Be-Announced Trading in the Mortgage-Backed Securities Market, The Journal of Finance, Vol. 72, Issue 3, pp. 1119–1170.

See regarding tail risk (in the eurozone): A. Lucas, et al., (2017), Modelling Financial Sector Tail Risk in the Euro Area, Journal of Applied Econometrics Vol. 32, pp. 171–191.

Which, at least politically, requires full fiscal consolidation.

See in extenso: B. Braun et al., (2018), Governing Through Financial Markets: Towards a Critical Economy of Capital Markets Union, Competition and Change, Vol. 22, Issue 2, pp. 101–116; L. Quaglia, (2016), The Political Economy of European Capital Markets Union, Journal of Common Market Studies, Vol. 54, S1, pp. 185–203. See also in detail regarding the use of financial instruments to reach beyond EU budgets: J.N. Ferrer et al., (2018), Expanding the Reach of the EU Budget Via Financial Instruments, CEPS Commentary, February 26.

R. Milne, (2011), Beware of Perceived Safe Havens: Favouring Triple A Government Debt Increases Systemic Risks, Financial Times, July 28.

P.G. Dunne, (2018), Positive Liquidity Spillovers from Sovereign Bond-Backed Securities, ESRB Working Paper Series Nr. 67, January; Y. Baranova, et al., (2017), Dealer Intermediation, Market Liquidity and the Impact of Regulatory Reform, Bank of England Staff Working Paper Nr. 665.

See A. van Riet, (2017), Addressing the Safety Trilemma: A Safe Sovereign Asset for the Eurozone, ESRB Working Paper Series, Nr. 35, pp. 35–38. Also van Riet prefers the synthetic model: pp. 38–47. See for a risk-safety model of the different options around: pp. 45, figure 5. See also S. Tober, (2016), The ECB’s Monetary Policy: Stability Without ‘Safe’ Assets, Han Böckler Stiftung, IMK Working Paper Series Nr. 9, May, pp. 1–13.

Asymmetric attention for perceived issues is common in literature, and resembles in this case political rhetoric. A. van Riet, (2017), ibid., pp. 46–48.

See in detail: A. Leandro and J. Zettelmeyer, (2019), The Search for a Euro Area Safe Asset, CEPR Discussion Paper Nr. DP12793, February, revised edition; also see ‘Europe’s Search for a Safe Asset’ aligned presentation 2018, March 23, for the Peterson Institute for International Economics. They highlight the following differences across a number of different important dimensions: ‘[a] euro area budget or wealth fund could create the largest volume of safe assets, followed by ESBies, E-bonds, and national tranching. A euro area budget or wealth fund is also likely to have the lowest impact on the structure and liquidity of national bond markets, while national tranching would have the largest impact. ESBies and E-bonds occupy an intermediate position. ESBies and potentially bonds issued by a euro area budget would offer their holders greater protection from deep national defaults than the other two proposals. Both ESBies and national tranching would avoid cross-country redistribution by construction, whereas E-bonds and a euro area budget could have significant distributional consequences, depending on their design. E-bonds are unique in that they would raise the marginal cost of sovereign debt issuance at higher levels of debt, thereby exerting fiscal discipline, without necessarily raising average debt costs for lower-rated borrowers.’ Creating safe assets by contract, that is, European bond-backed security (ESSBs), are just a CDO . Constructed safe assets are interesting only if they require neither mutual guarantees nor tranching.

In essence it is a macroeconomic stabilization fund financed by annual contributions from countries used to build up assets in good times and make transfers to countries in bad times, as well as a borrowing capacity in case large or persistent shocks exhaust the fund’s assets. See in detail: N.G. Arnold et al., (2018), A Central Fiscal Stabilization Capacity for the Euro Area, IMF Staff Discussion Notes, Nr. SDN/18/03, March.

See about the still problematic relationship between the EU and national supervisors, ten years after the crisis: W.P. De Groen and K. Zielińska, (2018), European Supervisory Authorities Still Playing Second Fiddle to National Financial Regulators, CEPS Commentary, March 14.

Maybe it wasn’t the demand for safe assets that went unnoticed, but the fact that the demand for safe assets has grown beyond its natural transactional and liquidity role. See in detail: T. Ahnert and E. Perotti, (2018), Seeking Safety, Bank of Canada Working Paper Nr. 41, August.

See how demographics and cash hoarding with a view toward building up retirement savings come with a full list of complications and the need to revise the legal settings for retirement schemes in: D. Amaglobeli et al., (2019), The Future of Saving: The Role of Pension System Design in an Aging World, IMF Staff Discussion Note, SDN/19/01, January.

See in detail C. Azariadis et al., (2015), Self-Fulfilling Credit Cycles, The Review of Economic Studies, Vol. 83, Issue 4, pp. 1364–1405.

Ahnert and Perotti describe the private industry of safe assets as ‘[t]he private provision of safety relies on carving safe claims out of risky investment’. See T. Ahnert and E. Perotti, (2017), Intermediaries as Safety Providers, Working Paper, May 8, mimeo. They conclude further: ‘higher safety needs do not simply reallocate risk bearing, as they can be satisfied only at the cost of increased fragility.’ Safe assets are priced above their implied risk-return trade-off, especially when the supply of public debt is low (p. 1). Also see J.R. Roderick et al., (2016), Warehouse Banking, Working Paper, March 30, mimeo.

P. Golec and E. Perotti, (2017), Safe Assets: A Review, ECB Working Paper Series Nr. 2035, March, p. 2.

See for a valuable and in-depth, but already a bit outdated, overview: P. Golec and E. Perotti, (2017), ibid.

In fact it was as early as 2005, during the credit boom from 2002 to 2007, that led to the Great Recession. See in detail S. Nagel, (2016), The Liquidity Premium of Near-Money Assets, The Quarterly Journal of Economics, Vol. 131, Issue 4, pp. 1927–1971; A. Sunderam, (2015), Money Creation and the Shadow Banking System, Review of Financial Studies, Vol. 28, pp. 939–977; C. Pérignon et al., (2017), Wholesale Funding Dry-Ups, ESRB Working Paper Series Nr. 49, July.

A. Krishnamurthy and A. Vissing-Jorgensen, (2012), The Aggregate Demand for Treasury Debt, Journal of Political Economy, Vol. 120, Issue 2, pp. 233–267; G. Gorton, et al., (2012), The Safe-Asset Share, American Economic Review, Vol. 102, Issue 3, pp. 101–106.

Through, for example, repos and commercial paper: A. Krishnamurthy and A. Vissing-Jorgensen, (2015), The Impact of Treasury Supply on Financial Sector Lending and Stability, Journal of Financial Economics, Elsevier, Vol. 118, Issue 3, pp. 571–600. This obviously leads to credit creation and an increase of net long-term investment with associated maturity transformation at the level of the intermediary.

See for an overview of literature on this matter: P. Golec and E. Perotti, (2017), Safe Assets: A Review, ECB Working Paper Series Nr. 2035, March, pp. 3–4.

See in detail: P. Golec and E. Perotti, (2017), ibid., pp. 5–8; A. van Riet, (2017), Addressing the Safety Trilemma: A Safe Sovereign Asset for the Eurozone, ESRB Working Paper Series Nr. 35, February, pp. 6–12.

See for an analysis of ‘crash risk’ in safe assets: A. Ben Nasr et al., (2018), Investor Sentiment and Crash Risk in Safe Havens, Working Paper, February 1, mimeo.

That idea has long been ignored, most likely as safe assets tend to have liquid secondary markets. But safe assets can be illiquid and risky assets can be more liquid than safe assets under market stress. See for an overview of the classification of different assets in the liquidity-safety matrix and aligned literature: P. Golec and E. Perotti, (2017), ibid. Figure 1, pp. 7–8. The major distinction is that absolute safe assets are government backed and issued and that private issued safe assets are safe and liquid outside of a crisis but no longer during a crisis.

See in detail: P. Golec and E. Perotti, (2017), ibid., pp. 8–13.

R. Greenwood and D. Vayanos, (2014), Bond Supply and Excess Bond Returns, Review of Financial Studies, Vol. 27, Issue 3, pp. 663–713; A. Sunderam, (2015), Money Creation and the Shadow Banking System, Review of Financial Studies, Vol. 28, Issue 4, April, pp. 939–977.

T. Ahnert and E. Perotti, (2015), Cheap but Flighty: How Global Imbalances Create Financial Fragility, Tinbergen Institute Discussion Papers 15–036/IV/DSF89, Tinbergen Institute; N. Gennaioli, et al.,(2013), A Model of Shadow Banking, The Journal of Finance, Vol. 68, Issue 4, pp. 1331–1363. Also see P. Golec and E. Perotti, (2017), ibid., pp. 13–16.

Banks create liquidity by issuing ‘safe assets’. They can be generated by either ‘holding asset to maturity and issuing risk-absorbing equity claims, or by fire-selling risky assets in downturns’. One could state that fire sales are always excessive, but that liquidity creation is not necessarily too high but can also be inefficiently low. The latter might be the result because ‘fire sales increase liquidity creation only if the equilibrium fire-sale price is sufficiently high, but start to destroy liquidity once the fire sale price is too low’. See: S. Luck and P. Schempp, (2018), Inefficient Liquidity Creation, Working Paper, March 21, mimeo; G. Gorton and E.W. Tallman, (2016) How Did Pre-Fed Banking Panics End? NBER Working Papers Nr. 22036.

E. Farhi and J. Tirole, (2015), Liquid Bundles, Journal of Economic Theory, Vol. 158, pp. 634–655; G. Gorton and G. Ordonez, (2014), Collateral Crises, American Economic Review, Vol. 104, Issue 2, pp. 343–378.

See for that in extenso: P. Golec and E. Perotti, (2017), ibid., pp. 20–23.

M. Eden and B. Kay, (2015), Safe Assets as Commodity Money, OFR Working Paper Nr. 15-23, November 25.

P. Golec and E. Perotti, (2017), ibid., p. 16.

Although even short-term private safe assets are sensitive to changes in the information environment and should not be treated as equally safe at all times. See M. Kacperczyk et al., (2017), The Private Production of Safe Assets, Working Paper, June 9, mimeo. The latter demonstrate that privately issued securities can benefit from a safety premium if their maturity is very short.

Short-term creditors can adjust their claim faster and more frequent than others based on information coming to the market, demand-supply dynamic in the market. The repricing, as a result, gives them an advantage over long-term creditors. You could say that short-term creditors are ‘de facto’ more senior due to their position in the cash flow repayment schedule. Risk intolerance then causes short-term spirals of debt issuance. More short-term debt also means more rollover risk. In extremis this might lead to coordination issues in the market even when the underlying fundamentals are economically sound. Also see S.G. Hanson, et al., (2015), Banks as Patient Fixed-Income Investors, Journal of Financial Economics, Vol. 117, pp. 449–469. What happens is that the short-term nature and the volume of rollover requirements do not allow for sufficient time to ‘reprice risk’ required to roll over debt. No rollover means assets need to be liquidated, thereby reducing asset value for remaining investors (those that approved debt rollover). See for that: R. Matta and E. Perotti, (2015), Secured vs. Unsecured, SRC Discussion Paper Nr. 41, July. See in detail regarding liquidity risk and bank runs under minimal fundamental risk: R. Matta and E. Perotti, (2017), Insecure Debt and Liquidity Runs, Working Paper, June 22, mimeo.

The market stay ‘contributes to a surprising concave effect of liquidity risk on run frequency, quite unlike fundamental risk. In general, abundant liquidity encourages rollover as it supports confidence that the bank can repay withdrawals. As some default risk arises, the appeal of running increases as asset liquidity falls, since runners are paid out of an increasingly scarce asset class. However, as liquid assets become extremely scarce the rollover payoff increases relative to the run payoff, as more assets will be left in the estate. Thus, in equilibrium there is a concave, inverted U-shaped relation between asset liquidity and run frequency’: R. Matta and E. Perotti, (2017), ibid., p. 3. Some compare it to a ‘Knightian uncertainty emerging’: R.J. Caballero, and E. Farhi, (2017), The Safety Trap, The Review of Economic Studies, Vol. 85, Issue 1, pp. 223–274.

Even more: the creation of private safe assets by shadow banks can crowd out traditional banks’ supply of safe assets. Narajabad and Gissler highlighted that ‘the 2014–2016 money market fund reform created a large demand shock for government- or government-like safe assets. Shadow banks responded, and in particular, Federal Home Loan Banks (FHLBs) increased their issuance of short-term safe debt as well as their lending to banks. To manage their interest rate risk, FHLBs changed the terms of their lending; the new loans had a shorter maturity and reset the interest rate at a high frequency.’ They study, through differences in interest rate management, the banks responses. The differential on borrowing by banks following the MMF reforms were studied as well as the effect of increased supply of safe assets by FHLB on banks’ balance sheets. They observe that ‘banks use FHLB borrowing as a perfect substitute for deposit financing. The substitution of safe debt with FHLB borrowing does not go along with an overall increase in the balance sheet and therefore has no lending effect.’ ‘If shadow banks create safe assets at the expense of traditional banks’ deposits, then there will be a minimal effect on the total funding available for households and firms from banks and shadow banks.’ See B. Narajabad and S. Gissler, (2018), Supply of Private Safe Assets: Interplay of Shadow and Traditional Banks, Working Paper, June 13, draft, mimeo.

Repos were considered safe and that understanding is built on the neoclassical premise that markets are reliable sources of liquidity. Reality disproved that thesis by generating collateral calls, collateral sales, liquidity events and liquidity-driven losses for repo-borrowing funds and their end investors. Repo-lending now dominates money markets and thus protect borrowers themselves through safe asset collateral. It is claimed that the potential is there for that situation can distort financial markets and disrupt private investment and economic performance. Sissoko analyzed and contrasted the liquidity-supporting role of the traditional banking system with the liquidity-demanding, repo-based financial system and concludes that the contractual structure determines the balance in the private loan sector and that, although private debt never is really free, the balance of safety has shifted, because of this trend, toward lenders. See C. Sissoko, (2017), Repurchase Agreements and the De(con)struction of Financial Markets, Working Paper, July 12. One can say it is a(n) (un)intended consequence of market-based finance.

In extenso: G. Coco, (2000), On the Use of Collateral, Journal of Economic Surveys, Vol. 14, Issue 2, pp. 191–214. For example, repos are not only exempted from automatic stay, but due to their short-term nature, haircuts can be adjusted on a frequent basis making them virtually risk-free.

See for that: M. Oehmke, (2014), Liquidating Illiquid Collateral, Journal of Economic Theory, Vol. 149, pp. 183–210.

The market for collateral also plays a role in the financial system and in particular with respect to financial stability and the conduct of monetary policy. Collateral is neither a sufficient nor a necessary condition for financial stability. To ensure the stability of collateralized markets a mix of micro- and macroprudential regulation, as well as a sufficient supply of safe public assets that can be used as collateral, is needed, conclude Corradin et al. See S. Corradin et al., (2017), On Collateral: Implications for Financial Stability and Monetary Policy, ECB Working Paper Nr. 2017, November.

P. Bolton, and M. Oehmke, (2014), Should Derivatives Be Privileged in Bankruptcy? The Journal of Finance, Vol. 70, Issue 6, pp. 2353–2394. See for a general review of the issue: F.R. Edwards and E.R. Morrison, (2005), Derivatives and the Bankruptcy Code: Why the Special Treatment, Yale Journal on Regulation, Vol. 22, pp. 101–133. This position continued under the new regulation in recent years: S. Adams, (2013), Derivatives Safe Harbors in Bankruptcy and Dodd-Frank: A Structural Analysis, Harvard University Working Paper, April 30, mimeo.

See for a variety of studies on the matter: A.B. Abel, (2017), Crowding Out in Ricardian Economies, Journal of Monetary Economics, Vol. 87, pp. 52–66; R.J. Barro, and T. Jin, (2016), Rare Events and Long-Run Risks, NBER Discussion Paper Nr. 115371; R.J. Barro et al.,(2017), Safe Assets, CEPR Discussion Paper Nr. DP12043; S.T. Rachev and F.J. Fabozzi, (2016), Financial Market with No Riskless (Safe) Asset, Working Paper, December 5; M. Lenel, (2017), Safe Assets, Collateralized Lending and Monetary Policy, Stanford University Working Paper, January 1, mimeo; P.-O. Gourinchas and O. Jeanne, (2012), Global Safe Assets, Paper presented at the XI BIS Annual Conference held in Lucerne, 20–21 June 2012, mimeo; IMF, (2012), Safe Assets: Financial System Cornerstone, Global Financial Stability Report, Chapter 3, pp. 81–122.

A. Gelpern and E.F. Gerding, (2016), Inside Safe Assets, Georgetown University Law Center Working Paper, September 26 (also as A. Gelpern and E.F. Gerding, (2016), Rethinking the Law in Safe Assets, Reconceptualising Global Finance and Its Regulation, (eds.) R. P. Buckley, E. Avgouleas, and D. W. Arner, Cambridge University Press, Cambridge). See for their earlier work in this field: A. Gelpern and E.F. Gerding, (2015), Private and Public Ordering in Safe Asset Markets, Brooklyn Journal of Corporate, Financial & Commercial Law Vol. 10, pp. 1–31.

See for the legal architecture of safe assets: A. Gelpern and E.F. Gerding, (2016), ibid., pp. 25–43.

A. Gelpern and E.F. Gerding, (2016), ibid., pp. 45–52.

Let’s be fair: even in case an AAA-rated sovereign issues bonds, they are only considered AAA not only because of the underlying fundamentals of its economic, trade balance and so on but particularly because the central bank in that country can at any time print additional debt to roll over any existing liability in its own currency the sovereign might have. That sounds like a free lunch was it not for the fact that monetary expansion creates a natural inflationary uptick and so the cost of that transaction is spread across society.

See for the proposed remedies which include: (1) cataloguing safe assets, who uses them and for what reason. The monitoring should allow timely review and realignment of assets, although that process is as burdensome as general macroprudential tools; (2) fixing wrongful labeling. Public labels are better than private labels only if they effectively can correct market failures. Label-as-price has minimal information value of its own, even as it tries to block market price signals, and its use should therefore be minimized. Those who now benefit will do whatever it takes to see labeling go away. See in detail A. Gelpern and E.F. Gerding, (2016), ibid., pp. 52–58.

A. Gelpern and E.F. Gerding, (2016), ibid., pp. 49–52. See in particular S.T. Omarova, (2013), The Merchant of Wall Street: Banking, Commerce and Commodities, Minnesota Law Review, Vol. 98, pp. 295–355; S.T. Omarova, (2009), The Quiet Metamorphosis: How Derivatives Changed the Business of Banking, University of Miami Law Review, Vol. 63, pp. 1041–1109. See for the moral hazard in this: S.L. Schwarcz, (2015), Derivatives and Collateral: Balancing Remedies and Systemic Risk, University of Illinois Law Review, Nr. 2, pp. 699–719.

See also S. Luck and P. Schempp, (2016), Regulatory Arbitrage and Systemic Liquidity Crises, Working Paper, mimeo; A. Moreira and A. Savov, (2017), The Macroeconomics of Shadow banking, The Journal of Finance, Vol. 72, Issue 6, pp. 2381–2432; G. Ordoñez, (2018), Sustainable Shadow Banking, American Economic Journal, Vol. 10, Nr. 1, January, pp. 33–56; P. Benigno and S. Nisticò, (2017), Safe Assets, Liquidity, and Monetary Policy, American Economic Journal, Vol. 9, Nr. 2, April, pp. 182–227.

Weymuller argues that banks hold so many government bonds, because their role is to multiply safety, and their Treasury holdings help them achieve exactly that. Private safety creation requires banks to hold on their balance sheets government bonds, whose returns are negatively correlated with macroeconomic shocks. The European debt crisis of a few years ago is therefore nothing less than a shortage of safe public assets. The spread between public debt yield and private debt yield reveals bank leverage. See in detail C.-H. Weymuller, (2015), Banks as Safety Multipliers: A Theory of Safe Asset Creation, Working Paper, May, mimeo.

A. Gelpern and E.F. Gerding, (2016), ibid., p. 55.

R. Caballero et al., (2017), Rents, Technical Change, and Risk Premia Accounting for Secular Trends in Interest Rates, Returns on Capital, Earning Yields, and Factor Shares, American Economic Review, Vol. 107, Issue 5, pp. 614–620.

T.V. Dang et al., (2015), Ignorance, Debt, and Financial Crises, Columbia Working Paper, April, mimeo; G.B. Gorton et al., (2016), The Safe-Asset Share, NBER Working Paper Nr. 22210.

E. Fahri and M. Maggiori, (2016), A Model of the International Monetary System, NBER Working Paper Nr. 22295; Z. He et al., (2016), What Makes US Government Bonds Safe Assets?, NBER Working Paper Nr. 22017.

G. Gorton, (2018), Financial Crisis, Annual Review of Financial Economics, Vol. 10, pp. 43–58.

See for the historical dimension in detail: G. Gorton, (2017), The History and Economics of Safe Assets in Detail, Vol. 9, pp. 547–586; Ŏ. Jordà et al., (2017), The Rate of Return on Everything, 1870–2015, Federal Reserve Bank of an Francisco Working Paper Series Nr. 2017-25, December.

R.J. Caballero et al., (2017), The Safe Assets Shortage Conundrum, Journal of Economic Perspectives, Vol. 31, Nr. 3, pp. 30.

R. Ahrend et al., (2017), The Demand for Safe Assets in Emerging Economies and Global Imbalances: New Empirical Evidence, Vol. 41, Issue 2, pp. 573–603; D. Bleich and A. Dombret, (2014), Financial System Leverage and the Shortage of Safe Assets: Exploring the Policy Options, German Economic Review, Vol. 16, Issue 2, pp. 161–180.

Government financial assets are increasingly recognized as playing an important role in assessing fiscal sustainability. See M. Ruzzante, (2018), Financial Crises, Macroeconomic Shocks, and the Government Balance Sheet: A Panel Analysis, IMF Working Paper Nr. WP/18/93, April. Also see A. Afonse et al., (2017), Fiscal Developments and Financial Stress: A Threshold VAR Analysis, Empirical Economics, pp. 1–29; E. Bova et al., (2016), The Fiscal Costs of Contingent Liabilities. IMF Working Paper Nr. WP/16/14.

R.J. Caballero et al., (2017), The Safe Assets Shortage Conundrum, Journal of Economic Perspectives, Vol. 31, Nr. 3, pp. 32–42. See about the role of central banks in affecting the quantity and mix of short-term liquid assets available to the market: M. Carlson et al., (2016), The Demand for Short-Term, Safe Assets and Financial Stability: Some Evidence and Implications for Central Bank Policies, IJCB, Vol. 12, Nr. 4, pp. 307–333.

S. Infante, (2017), Private Money Creation with Safe Assets and Term Premia, Finance and Economics Discussion Series Nr. 2017-041, via federalreserv.​gov.

S. Infante, (2017), ibid., p. 27. He also concludes that the creation of private safe assets with long-term public safe assets is beneficial because it shifts risk to agents which have a higher tolerance for it. Banks can satisfy demand for safe assets according to Infante by assuming the risk of government debt and issuing short-term claims, although the latter does not create but only transform them. Private safe asset creation occurs when the assets backing them do not already have a safe asset premium.

See for a historical review: G.B. Gorton et al., (2016), The Safe-Asset Share, NBER Working Paper Nr. 22210.

R.E. Hall, (2016), The Role of the Growth of Risk-Averse Wealth in the Decline of the Safe Real Interest Rate, Stanford Working Paper, mimeo.

J. Caballero et al., (2017), The Safe Assets Shortage Conundrum, Journal of Economic Perspectives, Vol. 31, Nr. 3, p. 40. G. Calvo, (2017), Liquidity Deflation and Safe Asset Shortage, Columbia Working Paper, mimeo.

See also W. Nelson, (2017), Recognizing the Value of the Central Bank as a Liquidity Backstop, The Clearing House Staff Working Paper Nr. 2017-1, January. Daniel Schwarcz leaves no room for doubt when claiming, ‘many of the assumptions on which state insurance regulation is premised are outdated or simply wrong’ and therefore ‘much of the current system of insurance regulation in the United States is obsolete, ineffective, and inefficient’. See D. Schwarcz, (2017), The Failures of State Insurance Regulation, ALI Early Career Scholars Medal address delivered at the American Law Institute’s 94th annual meeting in Washington, DC, on 24 May 2017. In fact, he goes further when indicating that ‘to protect the stability of the financial system, regulators and policy makers have been extending bankruptcy-resolution techniques beyond their normal boundaries’. The insufficiency lies in the fact that bankruptcy regulation has microprudential goals whereas financial stability is a macroprudential goal. See S.L. Schwarcz, (2019), Beyond Bankruptcy: Resolution as a Macroprudential Regulatory Tool, Duke Law School Public Law & Legal Theory Series Nr. 2017-53 (also in Notre Dame Law Review, Vol. 94, Issue 2, pp. 709–750).

R. J. Caballero et al., (2017), ibid., p. 40.

In fact Schulknecht argues that from a certain point more public debt will not ‘buy’ more safety: countries face a kind of ‘safe-assets Laffer curve’ with a maximum amount of safe assets at some level of indebtedness. See L. Schulknecht, (2016), The Supply of ‘Safe’ Assets and Fiscal Policy, CFS Working Paper Series Nr. 532.

See in detail J.C. Stein, (2012), Monetary Policy as Financial Stability Regulation, Quarterly Journal of Economics, Vol. 127, Issue 1, pp. 57–95; E. Farhi and M. Maggiori, (2016), A Model of the International Monetary System, NBER Working Paper Nr. 22295.

How much tail risk can the government absorb without ripping apart the public budget? Wouldn’t it then be better to issue the instruments themselves? What is the premium for tail risk we have a problem defining? Limiting tail risk to what we know creates open exposures. So this would become carte blanche and an absolute backstop by the government for a marginal insurance fee to allow unlimited rent extraction.

See for the analysis of the Ramsey model, the quest for a long-run optimal quantity of public debt and the possible policy responses to shocks: G.-M. Angeletos et al., (2016), Public Debt as Private Liquidity: Optimal Policy, Working Paper, October 28, mimeo; K. Aoki et al., (2014), Safe asset shortages and asset price bubbles, Journal of Mathematical Economics, Vol. 53 (C), pp. 164–174; Ph. Bacchetta et al., (2016), Money and Capital in a Persistent Liquidity Trap, CEPR Discussion Papers Nr. 11369, July.

The intrinsic characteristics and supply of the assets determine their liquidity properties and degree of safeness. With safe assets, we basically mean ‘information-insensitive’ assets. Only a sufficiently broad expansion of a particular class of safe information-insensitive assets can achieve the first-best allocation (safety as an equilibrium outcome), while a marginal increase in their supply can be ineffective. An asset is safe as long as there is no incentive to produce private information about its quality. Information can create volatility and makes it not suitable for facilitating transactions. Opacity trumps transparency (C. Monnet and E. Quintin, [2017], Rational Opacity, The Review of Financial Studies, Vol. 30, Issue 12, pp. 4317–4348.). A liquidity trap then means that only when a sufficient supply of safe assets is warranted the market can function at its optimal level, if not it is trapped. Safe asset scarcity therefore is a policy issue and producing private information (from information-insensitive to information-sensitive) implies an uncertainty about the outcome of a transaction. See in detail M. Lomberto, (2019), Safety Traps, Liquidity and Information-Sensitive Assets, Bank of Italy Working Papers Nr. 1216, April. The bottom line here is ‘[t]aking the safety of an asset as a primitive can provide wrong insights about the implications of a shortage of safe assets’ (p. 25). See broader for the constituents of safe assets: S. Nagel, (2015), What Is a Safe Asset, University of Michigan Presentation, June. Elements included are: (1) riskless payoff in real and nominal terms, (2) information-insensitive assets, (3) assets that satisfy regulatory constraints, (4) risky asset that pays promised stochastic payoff for sure and (5) negative beta assets. Loberto takes a different approach. In his model the degree of safeness of an asset is not an intrinsic characteristic. An asset is safe when it circulates in the economy and is accepted as a payment or collateral instrument without the incentive to check its quality every time. In detail: M. Loberto, (2019), Safety Traps, Liquidity and Information-Sensitive Assets, Bank of Italy Working Paper Nr. 1216, April 29.

Driven by regulation, reserve accumulation in the public and private sphere and most importantly demographics. See regarding the latter in specific: J. Callum, (2018), Aging, Secular Stagnation and the Business Cycle, IMF Working Paper Series Nr. WP/18/67, March 23.

In fact the story goes further: the costs and benefits of increasing government debt in a low interest rate environment are material. Higher risk increases the demand for safe assets, lowering the natural rate of interest below zero, constraining monetary policy at the zero lower bound, and raising unemployment. Higher government debt satiates the demand for safe assets without requiring negative interest rates, raising the natural rate and restoring full employment. This permanently lowers investments as discussed, but a commitment to low inflation leaves policy-wise no other options. See in detail: S. Acharya and K. Dogra, (2018), The Side Effects of Safe Asset Creation, Federal Reserve Bank of New York Staff Reports, Nr. 842, August. In contrast higher inflation targets permit both full employment and high investment, but allow for harmful bubbles which need to be tamed through aggressive fiscal policies. The fundamental problem is that the optimal natural allocation in a risky economy requires negative real rates to sustain high investment. See A. Martin and J. Ventura, (2018), The Macro-Economics of Rational Bubbles: A User’s Guide, NBER Working Paper Series Nr. 24234, January. Also see N. Caramp, (2016), Sowing the Seeds of Financial Crises: Endogenous Asset Creation and Adverse Selection, MIT Working Paper, mimeo.

M.K. Brunnermeyer and Y. Koby, (2016), The Reversal Interest Rate: The Effective Lower Bound of Monetary Policy, Working Paper Princeton University, mimeo; M. Del Negro et al., (2017), Safety, Liquidity, and the Natural Rate of Interest. Brookings Papers on Economic Activity, Nr. 1, pp. 235–316; R.J. Caballero and E. Farhi, (2018), The Safety Trap, Review of Economic Studies Vol. 85, Issue 1, pp. 223–274.

Investing in infrastructure might prove to be a good solution: lower bound risk combined with a boosting of potential growth and so optimizing the relation between invested capital and volume of safe assets generated.

As was argued by the discussed: J. Caballero et al., (2017), The Safe Assets Shortage Conundrum, Journal of Economic Perspectives, Vol. 31, Nr. 3, pp. 29–46; P.-O. Gourinchas and H. Rey, (2016), Real Interest Rates, Imbalances and the Curse of Regional Safe Asset Providers at the Zero Lower Bound, NBER Working Paper Nr. 22618, September.

See F. Dong and Y. Wen, (2017), Optimal Monetary Policy Under Negative Interest Rates, Federal Reserve Bank of St. Louis Working Paper Nr. 19A, St. Louis.

Zero lower bound (ZLB) in this context can be described as a situation where the short-term nominal interest rate is at or near zero, causing a liquidity trap and limiting the capacity (or the options) of the central bank to engage in actions to stimulate economic growth. See on the ZLB (and the impact on the economic environment and asset classes) in detail: S.D. Williamson, (2017), Low Real Interest rates and the Zero Lower Bound, Federal Reserve Bank of St. Louis, Working Paper Series Nr. 2017-010A, April; C.J. Gust et al., (2015), Monetary Policy, Incomplete Information and the Zero Lower Bound, Finance and Economics Discussion Series Nr. 2015-099, Washington: Board of Governors of the Federal Reserve System, November 3; R. Agarwal and M. Kimball, (2015), Breaking Through the Zero Lower Bound, IMF Working Paper Series Nr. WP/15/224, October; S. Schmidt, (2015), Lack of Confidence, the zero Lower Bound, and the Virtue of Fiscal Rules, ECB Working Paper Series Nr. 1795, May; H. Kick, (2017), Pricing of Bonds and Equity When the Zero Lower Bound Is Relevant, ECB Working paper Series Nr. 1992, January; M. Amador et al., (2017), Exchange rate Policies at the Zero Lower Bound, Federal Reserve Bank of Minneapolis Working paper Nr. 740, Revised October 2017; G. Bäurle et al., (2016), Changing Dynamics at the Zero Lower Bound, Swiss National Bank Working papers Nr. 16/2016, November; B. Feunou et al., (2017), Tractable Term-Structure Models and the Zero Lower Bound, Bank of Canada Working Paper Series Nr. 2015–46, December; D. Datta et al., (2017), Oil, Equities and the Zero Lower Bound, BIS Working Paper Nr. 617, March; D. Debortoli et al., (2018), On the Empirical (Ir)Relevance of the Zero Lower Bound Constraint, Working Paper, January, mimeo; M. Cacciatore and R. Duval, (2017), Market Reforms at the Zero Lower Bound, Working Paper, August, mimeo.

Kahn takes it the other way and describes how government borrowing can increase corporate investments. He explains: ‘corporations make endogenous corporate financing and investment decisions. The government affects these decisions through its issuance of safe debt. In the model, firms use safe assets to retain their earnings and avoid future financing costs. When the corporate sector is limited in its ability to create safe assets by the pledgeability of their capital, safe assets are scarce: a liquidity premium emerges, and the return on safe assets falls below the return on the firm in equilibrium. When safe assets are scarce, low interest rates on safe assets mean firms rely more on costly financing, resulting in lower investment. In this setting, in contrast to the common crowding-out story, increasing government borrowing raises the return on safe assets, making safe assets more available to firms and allowing them to better retain earnings in order to invest in the future.’ Kahn finds that a 1% increase in government borrowing increases the return on safe assets by 60 basis points and increases aggregate investment by 13 basis points. See in detail: R.J. Kahn, (2018), Corporate Demand for Safe Assets and Government Crowding-in, Working Paper, November 16, mimeo. Also interesting is the literature list pp. 45–47.

The authors conclude that although empirical evidence of the model is still out there the findings of the mode are ‘in some respects disturbingly similar to the experience of the U.S. and other advanced economies during the recovery from the Great Recession. These economies experienced a large increase in publicly issued safe assets (government debt held by the public and central bank reserves). Even after returning to full employment, output, investment, labor productivity, and capacity utilization have remained persistently below their pre-crisis trends.’ These outcomes they conclude are the unavoidable consequence of an increase in safe asset creation (pp. 30–31). See also F. Allen et al., (2017), On Interest Rate Policy and Asset Bubbles, Working Paper Series Nr. WP-2017-16, Federal Reserve Bank of Chicago.

See in detail: S. Biswas et al., (2018), Bubbly Recession, Federal Reserve Bank of Richmond Working Paper Series Nr. WP18-05, February; M. Boullot, (2016), Secular Stagnation, Liquidity Trap and Rational Asset Price Bubbles, Working Papers, mimeo; M. del Negro et al., (2017), Safety, liquidity, and the natural rate of interest, Staff Reports Nr. 812, Federal Reserve Bank of New York May; A. Martin and J. Ventura, (2018), The Macroeconomics of Rational Bubbles: A User’s Guide, NBER Working Paper Nr. 24234, January; F. Dong et al., (2018), Asset Bubbles and Monetary Policy, Working Paper, January, mimeo; T. Hirano and N. Yanagawa, (2017), Asset Bubbles, Endogenous Growth, and Financial Frictions, Review of Economic Studies, Vol. 84, pp. 406–443; D. Ikeda, (2017), Monetary Policy, Inflation and Rational Asset Price Bubbles, Working Paper, February, mimeo; J. Miao and P. Wang, (2017), Asset Bubbles and Credit Constraints, Working Paper, July 3, mimeo.

See in detail: J. Caballero et al., (2017), The Safe Assets Shortage Conundrum, Journal of Economic Perspectives, Vol. 31, Nr. 3, pp. 41–42; M. Azzimonti and P. Yared, (2019), The Optimal Public and Private Provision of Safe Assets, Journal of Monetary Economics, Vol. 102, pp. 126–144.

Global demand for safe assets will either remain dangerously unsatisfied, or force excessive US fiscal debt. This story posits implausibly inflexible demand for and supply of safe assets. See M.D. Bordo and R.N. McCauley, (2018), Triffin: Dilemma or Myth, NBER Working Paper Nr. 24195, January.

See about the impact of safe asset demand on exchange rates: Z. Jiang et al., (2018), Foreign Safe Asset Demand and the Dollar Exchange Rate, Working Paper, March 15, mimeo. And for their relationship with equity markets, see: R.N. McCauley, (2017), Risk-On/Risk-Off, Capital Flows, Leverage and Safe Assets, Journal of Financial Perspectives, Vol. 1, Nr. 2, pp. 1–10. McCauley describes the mutation from calm to volatile equity markets and the role of safe assets: ‘[t]hus, calm periods, marked by leveraged investing in emerging markets, lead to an asymmetric asset swap (risky emerging market assets against safe reserve currency assets) and leveraging up by emerging market central banks. In declining and volatile global equity markets, these flows reverse, and, contrary to some claims, emerging market central banks draw down reserves substantially.’ … ‘the international flow of funds produces not an exchange of risky assets, but an acquisition of risky assets on one side and acquisition of safe assets on the other.’

See also: R.J. Caballero et al. (2016), Safe Asset Scarcity and Aggregate Demand, American Economic Review Vol. 106, Issue 5, pp. 513–518; R.J. Caballero et al., (2017), Rents, Technical Change, and Risk Premia Accounting for Secular Trends in Interest Rates, Returns on Capital, Earning Yields, and Factor Shares, American Economic Review, Vol. 107, Issue 5, pp. 614–620; D. Andolfato and S. Williamson, (2015), Scarcity of Safe Assets, Inflation and the Policy Trap, Federal Reserve Bank of St. Louis, Working Paper Series, Nr. 2015-002A, January.

The sequence then is built up of assets in the shadow banking sphere during calm times to meet safe asset demand. When volatility kicks in, funding dries up and liquidation of assets is inevitable. By doing that the shadow banking segment exposes traditional banks to liquidity risk. See in detail: A. Ari et al., (2017), Shadow Banking and Market Discipline on Traditional Banks, IMF Working Paper Series Nr. WP/17/285, December. They correctly point out at the fact this has adverse implications. Traditional banks pursue risky portfolios that may leave them in default. But even more: trying to resolve the situation aimed at making traditional banks safer such as liquidity support, bank regulation and deposit insurance fuels further expansion of shadow banking but has luckily a net positive impact on financial stability. A shadow banking tax is also suggested to achieve financial stability (as an alternative).

Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on sovereign bond-backed securities, COM(2018) 339 final of 24 May 2018. At the time of the closing of the manuscript the proposal was only in its first reading at the level of the European Parliament and the Council. The outlook for the proposal is grim as objections persist. Politically it seems little realistic and the EU faces post May-2019 elections many more important and more urgent matters. However, just before the EP May 2019 elections, the ECB reiterated their interest and support for the SBBS product and philosophy. According to some members of the ECB Board the introduction would help shield the region’s financial markets from future crises. Politically, however, the idea still seems stillborn. See C. Look, (2019), ECB Call to Discuss Safe Assets Signals Renewed Push for Action, May 16, via bloomberg.​com

The Dutch CPB carefully and prudently conclude that ESBies might increase financial stability in the euro area. ESBies can achieve the goals of increasing the supply of safe assets and weakening the sovereign-bank nexus. ESBies may, however, suffer great losses in a systemic crisis, and the implicit guarantees by euro area states cannot be completely ruled out. See in detail: K. Ji, (2018), A Review on ESBies. The Senior Tranche of Sovereign Bond-Backed Securities, CPB Background Document, June. Also: M.K. Brunnermeier, et al. (2016), The Sovereign-Bank Diabolic Loop and ESBies, American Economic Review Papers and Proceedings Vol. 106, pp. 508–512. R.J. Caballero, et al. (2016), Safe Asset Scarcity and Aggregate Demand, American Economic Review Vol. 106, Nr. 5, pp. 513–518.

M. Amstad et al., (2016), How Do Global Investors Differentiate Between Sovereign Risks? The New Normal Versus the Old, BIS Working Paper Nr. 541, January. They observe sovereign risk through CDS spreads. While the movements in global risk factors determine whether CDS spreads rise or fall over time, the extent to which these spreads rise or fall depends on the country. They conclude that ‘CDS returns in the new normal move over time largely to reflect the movements of a single global risk factor, with the variation across sovereigns for the most part reflecting the designation of “emerging market”.’ Designation as an emerging or mature market, however, lacks the granularity that one would have expected for a fundamental on which investors’ risk assessments are based. Also interesting in this context is the fact that the historic understanding that sovereign debt in local currency is safer than debt in foreign currency is no longer carved in stone as it used to be. The traditional line of thinking was that sovereign always has control over the money supply in the local currency, something it lacks in foreign currency terms. Recent research, however, demonstrates that the gap still exists but has become much smaller than traditionally measured. A slow and steady convergence of sovereign risk in local and foreign currency over the past 20 years has been occurring. Amstad et al. observe that differences in inflation do not explain the assessed gaps between local and foreign currency credit risk (based on the credit rating of the three credit ratings provided by the global rating agencies). They find limited evidence of sovereigns’ willingness to inflate away their local debt in our measures of credit risk. The banking sector’s vulnerability to sovereign debt problems is a significant determinant of the spread, but does not account for its decline over time. Instead, the surge in global foreign exchange (FX) reserves, and to lesser extent the reduced reliance on overseas foreign currency borrowing (i.e. the decline of original sin), as well as lower global volatility, appear to have lessened the gap. See in detail: M. Amstad et al., (2018), Does Sovereign Risk in Local and Foreign Currency Differ, BIS Working Paper Nr. 709, March. Also observe the interesting literature list (pp. 21 ff.) regarding historic and contemporary research in the field related to the five ‘hypotheses’ to explain the traditional gap. In short the five arguments to explain the gap were: (1) the inflation hypothesis, that is, higher inflation lowers sovereign creditworthiness but less so for domestic currency debt—thus increasing the gap; (2) the reserves hypothesis, that is, high FX reserves (over GDP) increases creditworthiness, but more so for foreign currency obligations—thus diminishing the gap; (3) the original sin hypothesis, that is, lower original sin (greater international debt financing in local currency) raises sovereign creditworthiness and more so for foreign currency obligations—thus diminishing the gap; (4) the banking sector exposure hypothesis, that is, greater exposure of the banking sector to government bonds decreases sovereign creditworthiness, because of the mutual reinforcement of sovereign and financial system risk (the ‘doom loop’). Since this influence is expected to affect local currency obligations more strongly, banking sector exposure to sovereign risk will decrease the gap; and (5) the global volatility hypothesis, that is, high global volatility (as measured by VIX) lowers sovereign creditworthiness and more so for foreign currency obligations—thus increasing the gap.

J. Bruha and E. Kočenda, (2017), Financial Stability in Europe and Sovereign Risk, CESifo Working Paper Nr. 6453, Center for Economic Studies and Ifo Institute (CESifo) Munich, April. Their findings are mixed. In general, the stability and size of the banking industry are linked to lower sovereign risk in general. Foreign bank penetration and competition (a more diversified structure of the industry) are linked to lower sovereign risk. Bank efficiency (measured by lower NPLs) is correlated with lower sovereign risk. See also: C. Buch, et al. (2016), Banks and Sovereign Risk: A Granular View, Journal of Financial Stability, Vol. 25, pp. 1–15 R. Kallestrup et al., (2016), Financial Sector Linkages and the Dynamics of Bank and Sovereign Credit Spreads, Journal of Empirical Finance, Vol. 38, pp. 374–393; T. Klinger and P. Teplý, (2016), The Nexus Between Systemic Risk and Sovereign Crises. Czech Journal of Economics and Finance, Vol. 66, Issue 1, pp. 50–69; M.S. Pagano and J. Sedunov, (2016), A Comprehensive Approach to Measuring the Relation between Systemic Risk Exposure and Sovereign Debt, Journal of Financial Stability, Vol. 23, pp. 62–78; S. Yu, (2017), Sovereign and Bank Interdependencies—Evidence from the CDS Market, Research in International Business and Finance, Vol. 39, pp. 68–84.

See, for example, in detail K. Best, (2018), Shared Scepticism, Different Motives: Franco-German Perceptions of a Common European Asset, Jacques Delors Institute Berlin, Center for European Affairs at the Hertie School of Governance, Working Paper, October 28. Although Germany and France both rejected the SBBS proposal as ‘a deeper investigation into the safe asset debate in both countries reveals considerable differences in how policy makers engage with safe asset proposals, assess the costs and benefits, and set conditions for its acceptability. These are rooted in more fundamental differences between the two countries in beliefs, values, and interests linked to economic policy. Broadly, while the French debate is heterogenous, technical, and focused on assessing the present effectiveness of a safe asset in improving Euro area financial stability, the approach in Germany is more uniform, straightforward, and focused on avoiding moral hazard and other long-term risks,’ Best concludes.

A. Delivorias and J. Ulic, (2018), Sovereign Bond-Backed Securities, Risk Diversification and Reduction, Briefing EP, September 13; K. Brunnermeier et al., (2016), The Sovereign-Bank Diabolic Loop and Esbies, NBER Working Paper Nr. 21993, National Bureau of Economic Research, Cambridge, USA, February. Also N. Gennaioli, et al., (2018), Banks, Government Bonds, and Default: What Do the Data Say?, Journal of Monetary Economics, Vol. 98, pp. 98–113.

In the run-up to the European Parliamentary Elections of May 2019, the legislative process on this matter slowed significantly, and the Parliament or Council have not yet issued any draft position on the subject. It is for the new Parliament that comes in July 2019 to revive the whole thing. At this stage it is anticipated that it will take years for the idea to become reality and the risk still is that the idea will be stillborn. See for an analysis of the position pre-elections: J. Deslandes et al., (2018), Are Sovereign Bond-Backed Securities (‘SBBS’) a ‘Self-Standing’ Proposal to Address the Sovereign Bank Nexus, EP Briefing, September, via europarl.​europe.​eu

See for an overview: J. Deslandes et al., (2018), ibid., pp. 10–12.

M. Demary and J. Matthes, (2017), An Evaluation of Sovereign-Backed Securities (SBSs), Potentials, Risks and Political Relevance for EMU Reform, Cologne Institute for Economic Research, IW Paper Policy Paper Nr. 12/2017.

B. Smith-Meyer, (2018), No AAA for ESBies, May 30, via politico.eu.

‘Since some “AAA” rated sovereign bonds are likely to be repackaged into lower-rated ESBies’ according to a study done by the S&P in 2016: M. Kraemer, (2016), How S&P Global Ratings Would Assess European ‘Safe’ Bonds (ESBies), via politico.eu. S&P also indicates, in the same study, that given the lack of diversification of the sovereign bond portfolio underlying ESBies, and the high correlation of eurozone sovereign default risk, we would likely rate ESBies in the lower half of the investment-grade category. Credit ratings of SBBS would mainly depend on whether this financial instrument brings about the required level of diversification and low correlation.

A. Bénassy-Quéré et al., (2018), Reconciling Risk Sharing with Market Discipline: A Constructive Approach to Euro Area Reform, CEPS Policy Insight Nr. 91, January.

AFME, (2018), European Commission Inception Impact Assessment – Enabling regulatory framework for the development of sovereign bond-backed securities, Consultation response, February 20, via afme.eu.

G. Claeys, (2018), Are SBBS Really the Safe Asset the Euro Area are looking for, via bruegel.​org, May 28.

Economic and Financial Committee letter of 23 June 2017 to the DG Economic and Financial Affairs, via europe.eu.

G. Claeys, (2018), ibid.

N. Véron, (2017), Sovereign Concentration Charges: A New Regime for Banks’ Sovereign Exposure, Working Paper, via Bruegel.​org, November.

See N. Véron, (2017), ibid., p. 5.

G. Cappelletti et al., (2019), Impact of Higher Capital Buffers on Banks’ Lending and Risk-Taking: Evidence from the Euro Area Experiments, ECB Working Paper Nr. 2292, June. Banks identified as systemically important institutions reduced, in the short-term and when faced with capital surcharges given their systemic nature, their credit supply to households and financial sectors and shifted their lending to less risky counterparts within the nonfinancial corporation sector. In the medium term, the impact on credit supply is attenuated, and banks continue to shift their lending to less risky counterparts within the financial and household sectors.

D. Gros, (2018), Does the Euro Area Need a Safe or a Diversified Asset, CEPS Policy Brief, Nr. 3, Brussels, May 24. See in contrast the arguments of the EU in favor of an SBBS model: EC, (2018), Frequently asked questions: Enabling framework for sovereign bond-backed securities, Factsheet, Memo/18/3726, May 24.

See his memo for the technical workout, in particular pp. 3 ff.

M. Tonveronachi, (2018), European Sovereign Bond-Backed Securities: An Assessment and an Alternative Proposal, Levy Economics Institute of Baird College, Public Policy Brief Nr. 145. Tonveronachi already published earlier draft of his model; see: M. Tonveronachi, (2014), The ECB and the Single European Financial Market: A Proposal to Repair Half of a Flawed Design. Public Policy Brief Nr. 137. Annandale-on-Hudson, NY: Levy Economics Institute of Bard College. September. M. Tonveronachi, (2015), Revising ECB Operations and the European Fiscal Rules to Support Growth and Employment. Journal of Post Keynesian Economics, Issue 38, pp. 495–508. M. Tonveronachi, (2016), Three Proposals for Revitalizing the European Union. PSL Quarterly Review Vol. 69, Issue 279, pp. 301–336.

M. Tonveronachi, (2018), ibid., p. 4.

M. Tonveronachi, (2018), ibid., pp. 9–10.

See for criticism on the model: A. van Reit, (2017), Addressing the Safety Trilemma: A Safe Sovereign Asset for the Eurozone. ESRB Working Paper Nr. 35. Frankfurt am Main: European Systemic Risk Board. February

M. Tonveronachi, (2018), ibid., p. 10.

Liquidity and safety premia are the main drivers in the decline of the natural interest rate. See in detail: M. Del Negro et al., (2017), ‘Safety, Liquidity, and the Natural Rate of Interest’, Staff Reports Nr. 812, Federal Reserve Bank of New York, May.

Traditionally treated as the only ‘real safe asset’.

S. Acharya and K. Dogra, (2018), The Side Effects of safe Asset Creation, Federal Reserve Bank of New York Staff Reports, Mr. 842, August. They treat government debt as a ‘safe asset’ in the literal sense that ‘its return does not co-vary with a household’s marginal utility, unlike the return on capital, the other asset in our economy’ (p. 3). Other definitions focus on liquidity, default risk and so on—see footnote 9 for literature references. Also: R. Caballero et al., (2017), The Safe Asset Shortage Conundrum, Journal of Economic Perspectives, Vol. 31, Issue 3, pp. 29–46. Regarding the shortage of safe assets during periods of market stress, see R. Aggarwal et al., (2017), Safe Asset Shortages, Working Paper, December 15, mimeo. They first identify the unique role of the government bond lending market in accessing safe assets during periods of market stress. It gets interesting when they conclude that market participants are able to obtain safe assets using relatively low-quality non-cash collateral, allowing for collateral transformation. These attributes are important since they increase the velocity of safe assets and hence alleviate the pressure of safe asset shortages.

Most recently: E. Farhi, and M. Maggiori, (2018), A Model of the International Monetary System, Quarterly Journal of Economics, pp. 295–355.

S. Acharya and K. Dogra, (2018), ibid., p. 4.

S. Acharya and K. Dogra, (2018), ibid., p. 30.

Also: M. Magill et al., (2019), The Safe Asset, Banking Equilibrium, and Optimal Central Bank Monetary, Prudential and Balance Sheet Policies, Journal of Monetary Economics, available online, sciencedirect.​com, February 19.

S. Acharya and K. Dogra, (2018), ibid., p. 31.

R. N. McCauley, (2019), Safe Assets: Made, Not Just Born, BIS Working Paper Nr. 769, February.

M. Eden and B.S. Kay, (2018), Safe Assets as Commodity Money, Journal of Money, Credit and banking, available online through Wiley online library, October 8.

Z. He et al. (2019), A Model for Safe Asset Determination, American Economic Review, Vol. 109, Nr. 4, April, pp. 1230–1262.

See extensively: N. Gennaioli and A. Schleifer, (2018), A Crisis of Beliefs. Investor Psychology and Financial Fragility, Princeton University Press, NJ.