How the Financial System Works - A Map of Money Flows in the Global Financial Ecosystem - by Zoltan Pozsar Senior Adviser Office of Financial Research, U.S. Treasury 1 An Appendix to the paper “Shadow Banking: The Money View” (Pozsar, 2014) 1. The Hierarchy of Money. 2. The Hierarchy of Access. 3. The Hierarchy of Uses.. 4. The Dealer Eco-System. 5. The Macro Perspective. 6. Policy Implications... 2 Four core institutions: Central Bank (Federal Reserve) Central bank,… 3 Source: Pozsar (2014) Four core institutions: Central Bank (Federal Reserve) Central bank, banks (small and big),… Banks (retail) Banks (wholesale) 4 Source: Pozsar (2014) Four core institutions: Central Bank Dealer Banks (Federal Reserve) Central bank, banks (small and big), dealers,… Banks Dealer Banks (retail) Banks (wholesale) 5 Source: Pozsar (2014) Four core institutions: Central Bank Dealer Banks (Federal Reserve) Central bank, banks (small and big), dealers and money funds. Money Funds Banks Dealer Banks (retail) Banks Money Funds (wholesale) 6 Source: Pozsar (2014) Four core money claims: Central Bank Dealer Banks (Federal Reserve) Currency,… Currency Money Funds Banks Dealer Banks (retail) Banks Money Funds (wholesale) 7 Source: Pozsar (2014) Liabilities Four core money claims: Central Bank Dealer Banks (Federal Reserve) Currency, deposits,… Currency Money Funds Banks Dealer Banks (retail) Deposits (o/n) Banks Money Funds (wholesale) Deposits (o/n) 8 Source: Pozsar (2014) Liabilities Four core money claims: Central Bank Dealer Banks (Federal Reserve) Currency, deposits, repos,… Currency Repos (o/n) Money Funds Banks Dealer Banks (retail) Deposits Repos (o/n) (o/n) Banks Money Funds (wholesale) Deposits (o/n) 9 Source: Pozsar (2014) Liabilities Four core money claims: Central Bank Dealer Banks (Federal Reserve) Currency, deposits, repos Currency Repos and constant NAV shares. (o/n) Money Funds CNAVs (o/n) Banks Dealer Banks (retail) Deposits Repos (o/n) (o/n) Banks Money Funds (wholesale) Deposits CNAVs (o/n) (o/n) 10 Source: Pozsar (2014) Liabilities Two categories of assets: Central Bank Dealer Banks (Federal Reserve) Public assets: Currency Repos (o/n) T-Bills – Treasury bills T-Notes – Treasury notes Money Funds Public Assets CNAVs (o/n) Assets Banks Dealer Banks Private assets: (retail) Deposits Repos P-Bills - CD, CP, ECP, etc. (o/n) (o/n) P-Notes - bonds, RMBS, ABS Banks Money Funds (wholesale) Private Assets Deposits CNAVs (o/n) (o/n) 11 Source: Pozsar (2014) Liabilities Two categories of assets: Central Bank Dealer Banks (Federal Reserve) Public assets: T-Notes Currency Repos (o/n) T-Bills – Treasury bills T-Notes – Treasury notes Money Funds Public Assets CNAVs (o/n) Assets Banks Dealer Banks Private assets: (retail) Deposits Repos P-Bills - CD, CP, ECP, etc. (o/n) (o/n) P-Notes - bonds, RMBS, ABS Banks Money Funds (wholesale) Private Assets Deposits CNAVs (o/n) (o/n) 12 Source: Pozsar (2014) Liabilities Two categories of assets: Central Bank Dealer Banks (Federal Reserve) (government desk) Public assets: T-Notes Currency T-Bills T-Repos (o/n) T-Bills – Treasury bills … T-Notes – Treasury notes T-Notes T-Repos – Treasury repos Money Funds Public Assets CNAVs (o/n) Assets Banks Dealer Banks Private assets: (retail) Deposits Repos P-Bills - CD, CP, ECP, etc. (o/n) (o/n) P-Notes - bonds, RMBS, ABS Banks Money Funds (wholesale) Private Assets Deposits CNAVs (o/n) (o/n) 13 Source: Pozsar (2014) Liabilities Two categories of assets: Central Bank Dealer Banks (Federal Reserve) (government desk) Public assets: T-Notes Currency T-Bills T-Repos (o/n) T-Bills – Treasury bills … T-Notes – Treasury notes T-Notes T-Repos – Treasury repos Money Funds (government-only) T-CNAVs – Treasury CNAVs Public Assets T-Bills T-CNAVs (o/n) Assets Banks Dealer Banks Private assets: (retail) Deposits Repos P-Bills - CD, CP, ECP, etc. (o/n) (o/n) P-Notes - bonds, RMBS, ABS Banks Money Funds (wholesale) Private Assets Deposits CNAVs (o/n) (o/n) 14 Source: Pozsar (2014) Liabilities Two categories of assets: Central Bank Dealer Banks (Federal Reserve) (government desk) Public assets: T-Notes Currency T-Bills T-Repos (o/n) T-Bills – Treasury bills … T-Notes – Treasury notes T-Notes T-Repos – Treasury repos Money Funds (government-only) T-CNAVs – Treasury CNAVs Public Assets T-Bills T-CNAVs (o/n) Assets Banks Dealer Banks Private assets: (retail) P-Loans Deposits Repos P-Bills - CD, CP, ECP, etc. (o/n) (o/n) P-Notes - bonds, RMBS, ABS Banks Money Funds (wholesale) Private Assets Deposits CNAVs (o/n) (o/n) 15 Source: Pozsar (2014) Liabilities Two categories of assets: Central Bank Dealer Banks (Federal Reserve) (government desk) Public assets: T-Notes Currency T-Bills T-Repos (o/n) T-Bills – Treasury bills … T-Notes – Treasury notes T-Notes T-Repos – Treasury repos Money Funds (government-only) T-CNAVs – Treasury CNAVs Public Assets T-Bills T-CNAVs (o/n) Assets Banks Dealer Banks Private assets: (retail) P-Loans Deposits Repos P-Bills - CD, CP, ECP, etc. (o/n) (o/n) P-Notes - bonds, RMBS, ABS Banks Money Funds (wholesale) Private Assets P-Notes Deposits CNAVs (o/n) (o/n) … P-Loans 16 Source: Pozsar (2014) Liabilities Two categories of assets: Central Bank Dealer Banks (Federal Reserve) (government desk) Public assets: T-Notes Currency T-Bills T-Repos (o/n) T-Bills – Treasury bills … T-Notes – Treasury notes T-Notes T-Repos – Treasury repos Money Funds (government-only) T-CNAVs – Treasury CNAVs Public Assets T-Bills T-CNAVs (o/n) Assets Banks Dealer Banks Private assets: (retail) (credit desk) P-Loans Deposits P-Bills P-Repos P-Bills - CD, CP, ECP, etc. (o/n) (o/n) P-Notes - bonds, RMBS, ABS … P-Notes P-Repos – private repos Banks Money Funds (wholesale) Private Assets P-Notes Deposits CNAVs (o/n) (o/n) … P-Loans 17 Source: Pozsar (2014) Liabilities Two categories of assets: Central Bank Dealer Banks (Federal Reserve) (government desk) Public assets: T-Notes Currency T-Bills T-Repos (o/n) T-Bills – Treasury bills … T-Notes – Treasury notes T-Notes T-Repos – Treasury repos Money Funds (government-only) T-CNAVs – Treasury CNAVs Public Assets T-Bills T-CNAVs (o/n) Assets Banks Dealer Banks Private assets: (retail) (credit desk) P-Loans Deposits P-Bills P-Repos P-Bills - CD, CP, ECP, etc. (o/n) (o/n) P-Notes - bonds, RMBS, ABS … P-Notes P-Repos – private repos P-CNAVs – private CNAVs Banks Money Funds (wholesale) (prime) Private Assets P-Notes Deposits P-Bills P-CNAVs (o/n) (o/n) … P-Loans 18 Source: Pozsar (2014) Liabilities Deposits’ special function: Central Bank Dealer Banks (Federal Reserve) (government desk) Banks form the backbone of T-Notes Currency T-Bills T-Repos (o/n) the payments system and fa- … cilitate the net payments T-Notes (via deposits) of all enti- ties that are lower in the Money Funds system-hierarchy, including (government-only) Public Assets dealers and money funds. T-Bills T-CNAVs (o/n) Assets Banks Dealer Banks (retail) (credit desk) P-Loans Deposits P-Bills P-Repos (o/n) (o/n) … P-Notes Banks Money Funds (wholesale) (prime) Private Assets P-Notes Deposits P-Bills P-CNAVs (o/n) (o/n) … P-Loans 19 Source: Pozsar (2014) Liabilities Storing payment surpluses: Central Bank Dealer Banks (Federal Reserve) (government desk) What happens with net pay- T-Notes Currency T-Bills T-Repos (o/n) ment surpluses at the end of … the day? Through what ins- T-Notes truments are money balances stored within the system? Money Funds (government-only) Public Assets For every institution, money T-Bills T-CNAVs is something different. (o/n) This is the intra-system hierarchy of money… Assets Banks Dealer Banks (retail) (credit desk) P-Loans Deposits P-Bills P-Repos (o/n) (o/n) … P-Notes Banks Money Funds (wholesale) (prime) Private Assets P-Notes Deposits P-Bills P-CNAVs (o/n) (o/n) … P-Loans 20 Source: Pozsar (2014) Liabilities Intra-system money hierarchy: Central Bank Dealer Banks (Federal Reserve) (government desk) Reserves at the Fed T-Notes Currency T-Bills T-Repos Reserves (o/n) are money for banks. … (o/n) T-Notes Money Funds (government-only) Public Assets T-Bills T-CNAVs (o/n) Assets Banks Dealer Banks (retail) (credit desk) Reserves Deposits P-Bills P-Repos (o/n) (o/n) (o/n) … … P-Loans P-Notes Banks Money Funds (wholesale) (prime) Private Assets Reserves Deposits P-Bills P-CNAVs (o/n) (o/n) (o/n) … P-Loans 21 Source: Pozsar (2014) Liabilities Intra-system money hierarchy: Central Bank Dealer Banks (Federal Reserve) (government desk) o/n T-Repos with wholesale T-Notes Currency T-Repos T-Repos banks are money for dealers. Reserves (o/n) (o/n) (o/n) … T-Notes Money Funds (government-only) Public Assets T-Bills T-CNAVs (o/n) Assets Banks Dealer Banks (retail) (credit desk) Reserves Deposits P-Bills P-Repos (o/n) (o/n) (o/n) … … P-Loans P-Notes Banks Money Funds (wholesale) (prime) Private Assets Reserves T-Repos P-Bills P-CNAVs (o/n) (o/n) (o/n) … … P-Loans Deposits (o/n) 22 Source: Pozsar (2014) Liabilities Intra-system money hierarchy: Central Bank Dealer Banks (Federal Reserve) (government desk) o/n T-Repos w/ dealers are T-Notes Currency T-Repos T-Repos money for government MFs. Reserves (o/n) (o/n) (o/n) … T-Notes Money Funds (government-only) Public Assets T-Repos T-CNAVs (o/n) (o/n) … T-Bills Assets Banks Dealer Banks (retail) (credit desk) Reserves Deposits P-Bills P-Repos (o/n) (o/n) (o/n) … … P-Loans P-Notes Banks Money Funds (wholesale) (prime) Private Assets Reserves T-Repos P-Bills P-CNAVs (o/n) (o/n) (o/n) … … P-Loans Deposits (o/n) 23 Source: Pozsar (2014) Liabilities Intra-system money hierarchy: Central Bank Dealer Banks (Federal Reserve) (government desk) o/n P-Repos with dealers T-Notes Currency T-Repos T-Repos are money for prime MFs.