The art of central banking with global shadow banks

Elham Saeidinezhad

Chapter 12 in Central Banking, Monetary Policy and Financial In/Stability, 2025, pp 223-252 from Edward Elgar Publishing

Abstract: The provision of US dollar funding, essential to the international monetary system, has shifted from traditional bank loans to synthetic funding via FX swaps, with non-bank financial intermediaries like private investment funds, prime brokerages, and money market funds (MMFs) taking over. This chapter introduces a hierarchical dealer (HD) model to analyze the impacts of these structural shifts on global dollar funding markets, focusing on liquidity, financial stability, and the effectiveness of central bankers during crises. The HD model traces the intermediation chain through the federal funds, repo, Eurodollar, and FX swap markets, examining how this new market structure affects US dollar funding costs. In the inner layers of the monetary system, traditional US banks are being replaced by US prime brokerages and US MMFs, which do not use their balance sheets to absorb imbalances, leading to reduced liquidity and increased fragmentation. In the outer layers, non-US banks are exiting the provision of Eurodollar loans, replaced by non-US FX swap dealers who provide synthetic funding instead. In this new landscape, non-US investors face systematically more expensive and fragile dollar funding. These shifts pose significant challenges for central banks, impacting their ability to maintain financial stability. To effectively respond during a crisis, the Fed and other major central banks may need to adopt the unconventional role of becoming the private investment fund of last resort, a function that fundamentally contrasts the inherent DNA of central banking.

Keywords: Financial stability; Broker-dealer; US dollar funding; Covered interest parity; CIP (search for similar items in EconPapers)
Date: 2025
ISBN: 9781035302147
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