The Fed has published a staff report on the emergence of new banks that is sure to confound and distress some market participants. In the report, “Hybrid Intermediaries“, author Nicola Cetorelli argues that some of today’s nonbank intermediaries look very similar to earlier nonbank conglomerates that have become banks post-Lehman. BlackRock in securities lending is cited as an example. The subtext argument here is whether BlackRock and firms like it are SIFIs, should be forced to become bank holding companies, or receive some other form of bank-like regulation.
Cetorelli’s basic question is who provides financial intermediation. “The complex bank holding companies of today are the best example of hybrid intermediaries, but I argue that financial firms from the ‘nonbank’ space can just as easily evolve into conglomerates with similar organizational structure, thus acquiring the capability to engage in financial intermediation.”
We see bank-like offerings in practice pretty much all over the place, with hedge funds providing equity and fixed income liquidity, or Sovereign Wealth Funds providing collateral upgrade trades. Lots of players can be liquidity providers and use their balance sheets or legal status to provide financial intermediation. Where’s the line between bank and nonbank financial intermediation? Regulators call it Shadow Banking when it happens outside of a bank.
Cetorelli discusses the other side of the coin, which are banks and bank holding companies expanding their operations to meet clients where they are needed. As Cetorelli notes, “as banks witnessed the diminished role of commercial banking narrowly defined, they essentially adapted by “moving into the shadow,” thus expanding the boundaries of the banking firm to reflect the contribution of nonbank entities.” We think this point often gets lost in the Shadow Banking conversation: new entities are emerging, but banks are also expanding their own activities.
Cetorelli then moves to what other types of financial organizations look like the banks of today. The difference is that if banks are banks first then expand into other services, nonbanks take the other approach but wind up providing a similar raft of services.
BlackRock’s securities lending activities are used as an example of a nonbank firm offering a range of financial intermediation similar to a bank but technically as an asset manager. BlackRock arranges the securities loan, manages cash or non-cash collateral and provides indemnification to $130 billion as of mid-June 2014. “The firm also owns a broker-dealer, BlackRock Investments, LLC, and likewise, it manages various families of hedge funds as well, thus potentially having a full presence on the demand side of securities lending transactions.” To paraphrase the report’s argument, if it looks like a duck and quacks like a duck, then we should really be calling it a duck after all.
The kicker of course is how should nonbank entities be regulated when they are providing the same or an overlapping set of services as banks. “A focus on organizational structure and specific legal entities should also provide a valuable mapping of specific intermediation activities that, by their nature, may be difficult to subject to effective oversight. Finally, and complementary to the support to oversight, a focus on organizations may also facilitate the design of regulation aimed at containing the systemic externalities associated with these activities.” Just as MetLife had a proverbial cow when it was named a SIFI by the US Financial Stability Oversight Council, we expect that BlackRock, PIMCO, Vanguard and other big money managers may be very unhappy at where Cetorelli’s line of thinking ends up.