What was new over recent decades was the scale of its activities, which is closely related to the rapid expansion of securitisation. The securitisation of previously illiquid items in banks’ balance sheets gave perhaps the strongest boost to the financial sector. Securitisation allows traditional banking assets to be transformed into tradable instruments, thus creating tradable assets. It acts as a multiplier of negotiable financial claims or, more simply, a multiplier of finance. BIS Review 83/2010  1  Why was securitisation so essential to the expansion of shadow banks? The short answer to this question is that shadow banking serves as an intermediary for wholesale finance. In this segment of the financial system, lenders have large – and lumpy – financial resources to place with intermediaries for short periods of time, with no protection from formal deposit insurance mechanisms. This lack of formal insurance – since deposits are too large to be eligible for protection under national laws – calls for an informal or – I should rather say – market-based system of protection. This is precisely what the securitisation of assets can do: it can give financial intermediaries enough tradable securities to pledge as collateral for the large – lumpy – loans that they receive in the wholesale shadow-banking segment of their activities. The run-up to the crisis clearly showed that shadow banking and securitisation are not only interrelated but also that they interact.
For example, Adrian and Shin (2008) demonstrate that the balance sheets of US broker/dealers expand when monetary policy is accommodative. 6 Similar evidence is provided for the US repo market by Gorton and Metrick (2009), who found that activity started to increase significantly from 2001 – that is, at a time when monetary policy in the US was relatively loose following the bursting of the dot-com bubble. 7 Acharya and Schnabl (2010) provide similar evidence related to the asset-backed commercial paper (ABCP) market. 8 In summary, if the process that has been set in motion under the aegis of the G20 has the potential to place a whole new segment of finance under regulatory scrutiny and oversight, the new collateral-based finance can give a central bank stronger influence over financial and macroeconomic conditions more broadly. 5. Monetary policy in a high-debt environment  I mentioned earlier that collateral is likely to play a growing role in the functioning of capital markets. Demand for collateral is thus likely to increase. But, given the collapse of securitisation activity during the crisis, we could imagine that the current decline in the creation of securitised assets might become a permanent feature of the new landscape. There will be fewer ABSs created out of bank books. Sovereign debt will certainly be widespread. It will probably replace ABSs in the collateralisation of secured lending. Unlike in the past, the risk characteristics of this type of debt instrument will be more graduated than was considered possible only few years ago.