This paper provides an overview of the evolution as well as recent innovations in market-based finance (MBF). It argues that MBF is not merely an alternative way of providing banking-like services; it is in many ways a more efficient means of creating, distributing, and managing money, credit and risk globally. Properly regulated and supervised MBF can contribute to a dynamic and competitive financial services sector, develop new and innovative products to meet customers’ needs.
We have published this Occasional Paper alongside an article The rise of market based finance.
The paper has three broad objectives:
- to better understand the factors that have transformed the relatively simple traditional banking model into one that is increasingly global and market-based
- to develop an analytical framework to help us appreciate market-based finance’s (MBF) contribution to consumer welfare and identify its potential risks
- to gather information from various sources on recent developments and discuss their significance for the FCA as a securities markets and conduct regulator.
The paper concludes that MBF has grown in response to advances in financial engineering and the globalisation of funding and capital markets, enhancing efficiency through specialisation, giving it comparative advantages over the traditional (bank-based) model of finance. Specifically, it has achieved diversification of the types of funding available to loan-making institutions, geographical diversification of the investor base, and has contributed to the development of new products and services for risk distribution and management. The MBF ecosystem is constantly evolving, so new products and services which are currently not part of it can, over time, move inside the MBF perimeter if they become sufficiently large and interconnected.
Market-based finance has many benefits but there are some risks which should not be overlooked. The system is complex, still not very well understood and can at times be unstable. This is particularly true for some areas in which regulators have not yet gained access to data to assess the risks. For some products, unsolved market failures are present.
Matteo Aquilina and Wladimir Kraus.
Matteo Aquilina and Wladimir Kraus work in the Chief Economist’s Department of the Financial Conduct Authority.
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