The architecture of liquidity is changing

Global liquidity is entering a market-led regime as non-bank financial institutions take over a larger share of liquidity provision from banks and central banks.

• Liquidity means the ability to trade or obtain funding quickly, at reasonable cost and without materially moving prices; it depends on capital depth, transaction costs, price discovery, regulation, collateral, risk appetite, and market structure.
• The report identifies central banks, banks, and non-bank financial institutions as the main liquidity providers, with non-banks including insurers, pension funds, sovereign wealth funds, private asset funds, hedge funds, money market funds, principal trading firms, clearing participants, mutual funds, and ETFs.
• NYLIM’s framework measures bank, central-bank, and market liquidity using loan data, central-bank balance sheets and policy rates, money-market instruments, securitized loans, investment trusts, corporate bonds, and commercial paper; it gives 70% weight to the trailing 36-month marginal flow and 30% to structural stock.
• In the United States, the report distinguishes a bank-led regime from the 1980s to 2008, a central-bank-led regime during the Global Financial Crisis and pandemic eras, and a nascent market-led regime beginning around 2022.
• Before the Global Financial Crisis, commercial banks’ share of total nonfinancial borrowing fell from 35% in 1974 to 22% in 1995 as non-bank finance expanded, while regulatory changes culminated in the 1999 repeal of Glass-Steagall.

Takeaway: Investors should assess liquidity at the market-architecture level rather than only by asset or vehicle, because the growing role of non-banks may alter portfolio construction, risk positioning, and the effectiveness of central-bank backstops.