Similarly, dealers apparently are unwilling to provide the funding and the balance sheet capacity necessary for their leveraged clients to arbitrage away this dislocation. The degree to which this shift in the yield spread between Treasury and interest rate swap yields is due to the differential capital requirements imposed on cash versus derivative instruments warrants more investigation. Just as market and funding liquidity are interlinked, so are funding liquidity and capital requirements. All else equal, stronger capital requirements reduce firms’ vulnerability to runs. This suggests that funding liquidity risk can be addressed in many different ways. First, capital requirements can be bolstered to reduce the risk that a firm will become insolvent in particularly bad states of the world. Second, improved reporting and transparency can reduce the degree of uncertainty about whether a firm is solvent, thus reducing the risk that  6  Brunnermeier and Pedersen (2009) “Market Liquidity and Funding Liquidity” Review of Financial Studies 22(6) pp. 2201–2238 provide a theory that features strong correlation between market and funding liquidity during crises. 7  Hu, Pan, Wang (2013) “Noise as Information for Illiquidity” Journal of Finance 68(6), pp.2341–2382 provide further evidence on the relationship between yield curve fitting errors and alternative funding liquidity metrics. 4  BIS central bankers’ speeches  investors might wrongly perceive that a firm is insolvent, when, in fact, it still has adequate capital.
For this to become a reality, it will require a change in mindset and vision, coordination and investments by the industry today, to position itself for the future for a much bigger role in financing intangibles. The real economy is undergoing significant transformation and the financial sector has to keep pace. To remain relevant, just as financing looked to physical assets in the industrial age, it must look to intellectual assets in the information age. A first step needs to be taken. It needs to be taken expeditiously. 2  BIS central bankers’ speeches