This, in turn, has reduced the risk of lending out liquidity in the money market and thereby lowered the liquidity risk premia. 2 In crisis times, banks the world over learnt what Japanese banks learnt back in the 1990s: that they could manage their liquidity requirements – perhaps more comfortably and at lower cost – through central bank intermediation rather than via their traditional money market activities. Central banks – for their part – have seen that their collateralised lending has made them key market makers at a time when markets were disappearing. 3. The role of central banks in money markets  In light of all these developments we may well ask whether the new market-making role of central banks will continue. If central banks intermediate large volumes in normal times, they may not need to change their operational framework substantially when a liquidity crisis suddenly hits. Larger intermediation could anchor expectations and make market dynamics less subject to threshold effects. Does this suggest a new steady state – beyond the setbacks and progress of the current crisis – in which central banks will become a larger counterparty to the financial system as a whole? It is too early to say. Nevertheless, let me share with you some preliminary thoughts on the future role of central bank intermediation. Let me say up front that central bank intermediation involves subtle trade-offs. Let me list some of them.
If we want central bank control over leverage to be stronger in the future, shadow banks need to be part of what we consider “banks” tout court. In fact, by 2007 the size of the official and shadow banking systems, measured by the total amount of assets, had become essentially the same. 3 But there is also an issue of quality – or, if you prefer, of composition – of finance. Due to the increased risk aversion resulting from the financial crisis, collateralised lending is bound to increase in the future, even in markets where traditionally unsecured lending was the most important source of finance (e.g., the euro area interbank market). As a consequence, the demand for securitised assets – of the type that shadow banks have learned to create in the past – is set to increase further in the future, as institutions demand such types of debt to use as collateral. To put it in a nutshell, we will continue to need the functions, the financial products and the expertise that the shadow banks have been offering. But, we need to make sure that these activities are performed in a non-disruptive way. The new financial landscape can also reinforce the effectiveness of monetary policy. I already mentioned that most of the funding of financial institutions – whether banks, brokerdealers, hedge funds or shadow banks – is short-term. In other words, a key function of the financial system is maturity transformation.