U.S. banks on the sidelines. Chart: WSJ
In the wake of the worst financial crisis since the Great Depression, we’re witnessing a seismic shift in the markets—one that doesn’t involve the world’s biggest banks.
As the Wall Street Journal pointed out earlier this month during a week of enormous market volatility, major banks—who are traditionally the biggest actors in profiting on such gyrations by providing liquidity—were noticeably absent. The WSJ described it as the end of an era.
This is part of a larger trend in the system. Straddled by regulations like the Volcker rule and in an effort to minimize risk, especially in businesses that aren’t directly related to customers, banks are pulling out of market making activities. As Skylands Capital senior trader Tom Heardon explained to the WSJ: “The banks are not part of the market narrative right now.”
The drop-off in participation from big U.S. banks has sparked a broader discussion on the state of market liquidity this year. In July, BlackRock, one of the world’s largest asset managers, published a report on liquidity challenges. Goldman Sachs would later do the same. The ongoing conversation would culminate in a blog series by the Federal Reserve Bank of New York on the this very subject last month.
None of this, of course, portends a long term deterioration in market liquidity. Instead, what we’re witnessing are signs of transition where the massive vacuum left by big banks will soon be filled by non-traditional actors, according to Citadel’s head of market making Jamil Nazarali. As a non-bank financial institutions, Citadel has one of the largest market making businesses in the world, accounting for a quarter of all U.S.-listed stock trades for retail investors, according to a report by Institutional Investor last year.
Prominent economist and Fed vice-chairman Stanley Fischer echoed these sentiments in a speech he made in Germany this past spring, emphasizing the “important role the nonbank financial sector plays.”
“The U.S. financial system has changed a great deal over the past several decades,” Fischer said. “One of the most important changes has been the rapid growth of the nonbank sector.”
