Financial stress Prior to 2015, financial stress indicators exhibited a strong co-movement with the dispersion index (Slide 4). However, this relationship has since become less pronounced. The de-coupling of financial stress indicators and the dispersion index is particularly striking during the recent pandemic period. In the spring of 2020, when indicators of financial stress increased dramatically, the dispersion index of overnight money market rates remained at remarkably low levels, mainly owing to the structural shift to largely secured transactions and the high amounts of central bank liquidity outstanding even before the pandemic. The low dispersion across overnight rates during the pandemic stands in contrast to the sharp and persistent rise in term money market and commercial paper rates, which points to measurable tensions in other segments of the market (left-hand side of Slide 5). Commercial paper rates rose quickly as the demand for commercial paper from non-bank financial institutions froze at the height of the pandemic crisis. In March 2020, investment and money market funds faced heavy withdrawals from their investors due to a dash for cash and tried to sell off commercial paper before maturity to build up liquidity buffers. [12] The events of the spring therefore clearly demonstrated the extent to which the liquidity management policies of non-banks can have severe ramifications for broader market functioning and hence also for the transmission of monetary policy.
[5] The expansion of central bank liquidity provision during and after the global financial crisis substituted for impaired markets and thereby further reduced the need of market participants to rely on money markets for their liquidity. Instead, a substantial part of money market transactions in recent years has been driven by the demand for specific types of collateral. [6] Additionally, as a result of changes in the regulatory environment, unsecured money market transactions have become more costly in terms of bank capital and liquidity requirements. [7] This development has reinforced the shift towards secured money market transactions. Another trend is the marked shift in the types of counterparties involved in money market transactions. An increasing share of trades is cleared through central counterparties (CCPs) (right-hand side of Slide 1). CCPs mitigate counterparty risk and reduce the reliance on costly collateral by providing netting services. [8] They have been an integral part of the policy response to the shortcomings uncovered by the global  financial crisis. Beyond the use of CCPs, the share of transactions between banks and non-banks has gradually increased, whereas banks have lower incentives to transact with each other in the current environment of abundant central bank liquidity. These trends likely contributed to the relative resilience of short-term money markets since the onset of the COVID-19 pandemic. Secured transactions, a majority of which are cleared by CCPs, have been much less affected by the tensions in the spring than unsecured trades.