Capital Segmentation, Non-Banking Financial Institution Behavior, and Central Bank Monetary Policy Transmission

Non-bank financial intermediaries play an important role in the financial system as a vital supplement to commercial banks. They contribute to diversified financing channels, liquidity provision, market making, central counterparty agency, payment and settlement, as well as credit intermediation functions such as residents’ pension and wealth management. However, some non-bank financial institutions have low transparency of underlying assets, incomplete regulatory frameworks, and lack legal binding in information disclosure. Coupled with leverage nesting and concentration of certain businesses in the lower-tier credit markets, they can also become significant sources of stock and bond volatility or even systemic risk. Additionally, since non-bank financial institutions do not have deposit insurance like commercial banks and most are not qualified as primary dealers in central bank open market operations, some insurance businesses lack reinsurance coverage. Most activities are conducted through liquidity providers and central counterparty agents, without a final lender or market maker. Currently, interactions between non-bank financial institutions and commercial banks are becoming more frequent. Financial and technological innovations are deeply intertwined, creating ongoing regulatory gaps. Since the subprime mortgage crisis, the overall risk exposure of global non-bank financial institutions has been higher than that of the banking system. The 2008 global financial crisis, the March 2020 turmoil in the US capital markets, and the series of private credit defaults in the US since 2024 all indicate that non-bank financial institutions may become a significant source of systemic financial risk.

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