The Changing Nature of Financial Intermediation and the Financial Crisis of 2007–2009

TLDR

The financial crisis has exposed the evolving role of financial institutions and the expanding shadow banking system, driven by asset securitization and the blending of banking with capital markets, a trend most pronounced in the U.S. but with global impact, where balance‑sheet growth of market‑based intermediaries signals liquidity and crises are linked to balance‑sheet contractions. The study aims to describe the changing nature of financial intermediation, chart the recent financial crisis, and outline policy responses by the Federal Reserve and other central banks.

Abstract

The current financial crisis has highlighted the changing role of financial institutions and the growing importance of the shadow banking system, which grew on the back of the securitization of assets and the integration of banking with capital market developments. This trend has been most pronounced in the United States but has had a profound influence on the global financial system as a whole. In a market-based financial system, banking and capital market developments are inseparable, and funding conditions are closely tied to the fluctuations in leverage of market-based financial intermediaries. Balance-sheet growth of market-based financial intermediaries provides a window on liquidity in the sense of the availability of credit, whereas financial crises tend to be associated with contractions of balance sheets. We describe the changing nature of financial intermediation in the market-based financial system, chart the course of the recent financial crisis, and outline the policy responses that have been implemented by the Federal Reserve and other central banks to counter it.