how the financial system works

How the Financial System Works

1

- A Map of Money Flows in the Global Financial Ecosystem -

by Zoltan Pozsar

An Appendix to the paper Shadow Banking: The Money View (Pozsar, 2014)

Senior Adviser

Office of Financial Research, U.S. Treasury

2. The Hierarchy of Access.

2

3. The Hierarchy of Uses..

4. The Dealer Eco-System.

1. The Hierarchy of Money.

5. The Macro Perspective.

6. Policy Implications...

Four core institutions:

Central bank,

Source: Pozsar (2014)3

Central Bank

(Federal Reserve)



Central bank, banks (small and

big),

Central Bank

(Federal Reserve)

Banks

(retail)

Banks

(wholesale)




big), dealers,

Central Bank

(Federal Reserve)Dealer Banks

Banks

(retail)Dealer Banks

Banks

(wholesale)




big), dealers and money funds.

Central Bank


Money Funds

Banks


Money FundsBanks

(wholesale)

Four core money claims:

Currency,


Central Bank


Currency

Money Funds

Banks


Money Funds

Liabilities

Banks

(wholesale)



Currency, deposits,

Liabilities

Banks

(wholesale)

Deposits

(o/n)

Banks


Deposits

Money Funds

(o/n)

Central Bank


Currency

Money Funds



Currency, deposits, repos,

(o/n)

Liabilities

Banks

(wholesale)

Deposits

(o/n)

Banks


Deposits

Money Funds

Repos

(o/n)

Central Bank


Currency Repos

(o/n)

Money Funds



Currency, deposits, repos

and constant NAV shares.

(o/n)

Liabilities

CNAVs

(o/n)

Banks

(wholesale)

Deposits

(o/n)

CNAVs

Banks


Deposits

Money Funds

(o/n)

Repos

(o/n)

Central Bank


Currency Repos

(o/n)

Money Funds


Two categories of assets:

Public assets:

T-Bills Treasury bills

T-Notes Treasury notes

Private assets:

P-Bills - CD, CP, ECP, etc.

P-Notes - bonds, RMBS, ABS

Liabilities

Deposits CNAVs

(o/n) (o/n)

Repos

(o/n) (o/n)

Banks

(wholesale)Money Funds

(o/n)

Private Assets

Banks


Deposits

(o/n)

Money Funds

CNAVs

Assets

Public Assets

Central Bank


Currency Repos



Public assets:



Private assets:



Liabilities

CNAVs

(o/n)

Deposits

(o/n)

(o/n)

Private Assets

Banks


Deposits

Money Funds

(o/n)

CNAVs

Dealer Banks

T-Notes Currency Repos

(o/n)

Assets

Public Assets

Central Bank

(Federal Reserve)

Banks

(wholesale)

Money Funds

(o/n)

Repos



Public assets:



T-Repos Treasury repos

Private assets:



Liabilities

Deposits CNAVs

(o/n) (o/n)

Repos

(o/n) (o/n)

Banks


(o/n)

Private Assets

Banks


Deposits

(o/n)

T-Notes

Money Funds

CNAVs

Assets

Public Assets

Central Bank

(Federal Reserve)

Dealer Banks

(government desk)

T-Notes Currency T-Bills T-Repos



Public assets:




T-CNAVs Treasury CNAVs

Private assets:



Liabilities

Deposits CNAVs

(o/n) (o/n)

Repos

(o/n) (o/n)

Banks


(o/n)

Private Assets

Banks


Deposits

(o/n)

T-Notes

Money Funds

(government-only)

T-Bills T-CNAVs

Assets

Public Assets

Central Bank

(Federal Reserve)

Dealer Banks

(government desk)




Public assets:





Private assets:



T-Notes

Assets

Public Assets

Central Bank

(Federal Reserve)

Dealer Banks

(government desk)


(o/n)

Money Funds

(government-only)

T-Bills T-CNAVs

Private Assets

Banks


P-Loans Deposits

Money Funds

(o/n) (o/n)

Banks

(wholesale)

Deposits

(o/n)

(o/n)

Repos

Liabilities

CNAVs

(o/n)



Public assets:





Private assets:



P-Notes Deposits CNAVs

Liabilities

(o/n) (o/n)

P-Loans

(o/n) (o/n)

Banks


T-Notes

Money Funds

(government-only)

Private Assets

Banks


P-Loans Deposits

(o/n)

Repos

T-Bills T-CNAVs

Assets

Public Assets

Central Bank

(Federal Reserve)

Dealer Banks

(government desk)


(o/n)



Public assets:





Private assets:



P-Repos private repos

P-Notes Deposits CNAVs

Liabilities

(o/n) (o/n)

P-Loans

(o/n)

(o/n)

Banks


T-Notes

Money Funds

(government-only)

Private Assets

Banks

(retail)

Dealer Banks

(credit desk)

P-Loans Deposits P-Bills

P-Notes

(o/n)

P-Repos

T-Bills T-CNAVs

Assets

Public Assets

Central Bank

(Federal Reserve)

Dealer Banks

(government desk)


(o/n)



Public assets:





Private assets:



P-Repos private repos

P-CNAVs private CNAVs

P-Notes Deposits P-Bills P-CNAVs

Liabilities

(o/n) (o/n)

P-Loans

(o/n)

(o/n)

Banks

(wholesale)

Money Funds

(prime)

T-Notes

Money Funds

(government-only)

Private Assets

Banks

(retail)

Dealer Banks

(credit desk)


P-Notes

(o/n)

P-Repos

T-Bills T-CNAVs

Assets

Public Assets

Central Bank

(Federal Reserve)

Dealer Banks

(government desk)


(o/n)


Deposits special function:

Banks form the backbone of

the payments system and fa-

cilitate the net payments

(via deposits) of all enti-

ties that are lower in the

system-hierarchy, including

dealers and money funds. T-Bills T-CNAVs

Assets

Public Assets

Central Bank

(Federal Reserve)

Dealer Banks

(government desk)


(o/n)

T-Notes

Money Funds

(government-only)

Private Assets

Banks

(retail)

Dealer Banks

(credit desk)


P-Notes

(o/n)

P-Repos

(o/n)

(o/n)

Banks

(wholesale)

Money Funds

(prime)


Liabilities

(o/n) (o/n)

P-Loans


Storing payment surpluses:

What happens with net pay-

ment surpluses at the end of

the day? Through what ins-

truments are money balances

stored within the system?

For every institution, money

is something different.

This is the intra-system

hierarchy of money


Liabilities

(o/n) (o/n)

P-Loans

(o/n)

(o/n)

Banks

(wholesale)

Money Funds

(prime)

T-Notes

Money Funds

(government-only)

Private Assets

Banks

(retail)

Dealer Banks

(credit desk)


P-Notes

(o/n)

P-Repos

T-Bills T-CNAVs

Assets

Public Assets

Central Bank

(Federal Reserve)

Dealer Banks

(government desk)


(o/n)


Intra-system money hierarchy:

Reserves at the Fed

are money for banks.(o/n)

P-Loans

Assets

Public Assets

Central Bank

(Federal Reserve)

Reserves

P-Loans

Dealer Banks

(government desk)


(o/n)

T-Notes

Money Funds

(prime)

Reserves

(o/n)

T-Bills T-CNAVs

Money Funds

(government-only)

Private Assets

Banks

(retail)

Dealer Banks

(credit desk)

Reserves Deposits P-Bills P-Repos

(o/n) (o/n) (o/n)

P-Notes

Liabilities

(o/n) (o/n) (o/n)

Banks

(wholesale)

Deposits P-Bills P-CNAVs



o/n T-Repos with wholesale

banks are money for dealers.(o/n)

Assets

Public Assets

Central Bank

(Federal Reserve)

Reserves

Banks

(wholesale)

P-Loans

Dealer Banks

(government desk)

T-Notes Currency T-Repos T-Repos

(o/n) (o/n)

T-Notes

(o/n)

Money Funds

(government-only)

T-Bills T-CNAVs

Private Assets

Banks

(retail)

Dealer Banks

(credit desk)


(o/n) (o/n) (o/n)

P-Loans

P-Notes

Money Funds

(prime)

Liabilities

Reserves T-Repos P-Bills P-CNAVs

(o/n) (o/n) (o/n)

Deposits

(o/n)



o/n T-Repos w/ dealers are

money for government MFs.

P-Loans

P-Loans

(o/n)

Assets

Public Assets

Central Bank

(Federal Reserve)

Reserves

Private Assets

Banks

(retail)

(o/n) (o/n)

Dealer Banks

(government desk)


(o/n) (o/n)

T-Notes

Money Funds

(government-only)


T-Repos T-CNAVs

(o/n) (o/n)

(o/n)

Dealer Banks

(credit desk)

(o/n)

P-Notes

Banks

(wholesale)

Money Funds

(prime)

Liabilities

T-Bills

Deposits

(o/n)

Reserves T-Repos P-Bills P-CNAVs

(o/n) (o/n)



o/n P-Repos with dealers

are money for prime MFs.

Assets

Public Assets

Central Bank

(Federal Reserve)

Dealer Banks

(government desk)


Reserves (o/n) (o/n)

(o/n)

T-Notes

(o/n) (o/n)

Money Funds

(government-only)

T-Repos T-CNAVs

T-Bills

Private Assets

Banks

(retail)

Dealer Banks

(credit desk)

Reserves Deposits P-Repos P-Repos

(o/n) (o/n) (o/n)

P-Loans P-Notes

Banks

(wholesale)

Money Funds

(prime)

Reserves T-Repos P-Repos P-CNAVs

Liabilities

(o/n)


(o/n)

(o/n) (o/n) (o/n) (o/n)


Liabilities

?


(o/n)

(o/n) (o/n) (o/n) (o/n)

Banks

(wholesale)

Money Funds

(prime)


P-Loans P-Notes

P-Repos

(o/n) (o/n) (o/n) (o/n)

T-Bills

Private Assets

Banks

(retail)

Dealer Banks

(credit desk)

Reserves Deposits P-Repos

(o/n) (o/n)

Money Funds

(government-only)

T-Repos T-CNAVs

(o/n) (o/n)

(o/n)

T-Notes

Assets

Public Assets

Central Bank

(Federal Reserve)

Dealer Banks

(government desk)


Reserves


The sovereign as a bank:

Without the sovereign the

money matrix is incomplete.

We do not typically think

of her as a bank, but the

sovereign is also capable

of absorbing money demand.

Assets

Public Assets

Central Bank

(Federal Reserve)

Dealer Banks

(government desk)



(o/n)

T-Notes

(o/n) (o/n) (o/n) (o/n)

Sovereign

(U.S. Treasury)

Money Funds

(government-only)

Reserves T-Bills T-Repos T-CNAVs

Private Assets

Banks

(retail)

Dealer Banks

(credit desk)


(o/n) (o/n) (o/n) (o/n)

P-Loans

T-Bills

P-Repos

P-Notes

Banks

(wholesale)

Money Funds

(prime)


(o/n) (o/n) (o/n) (o/n)

Liabilities


(o/n)


What are money-like claims?

Par at maturity versus

par on demand claims.

Par at maturity in the

near term (o/n < 1 yr).

Breakable and negotiable

claims that do not trade

at par in real time (puts

prior to maturity subject

to penalty, market risks).

Liabilities


(term) (term)

(o/n) (o/n) (o/n) (o/n)

Banks

(wholesale)

Money Funds

(prime)


P-Repos

P-Notes P-Repos

(term) (term)

P-Loans Deposits

T-Bills T-Bills

(term) (term)

Private Assets

Banks

(retail)

Dealer Banks

(credit desk)


(o/n) (o/n) (o/n) (o/n)

T-Notes T-Repos

(o/n) (o/n) (o/n) (o/n)

Sovereign

(U.S. Treasury)

Money Funds

(government-only)

Reserves T-Bills T-Repos T-CNAVs

Assets

Public Assets

Central Bank

(Federal Reserve)

Dealer Banks

(government desk)



(o/n)

(term)

The alchemy of banking:

Take more [o/n liquidity],

give less [o/n liquidity]

and put the rest in term


(term)


T-Notes T-Repos

(term)

how the financial system works

Documents

banks small

money view pozsar

categories of assets

hierarchy of money

core institutions

map of money flows

cnavs treasury cnavsprivat

financial system works1