FSB: Money Market Vulnerabilities Could Cause ‘Larger Contagion’

The Financial Stability Board said regulations governing money market funds must be stronger.

The group’s Thematic Review on Money Market Fund (MMF) Reforms, published Tuesday (Feb. 27), found that the largest vulnerability facing these funds is the difficulty of cashing out investments to meet investment demands.

“The main identified vulnerability is the mismatch between the liquidity of money market fund asset holdings and the redemption terms offered to investors, which makes money market funds susceptible to runs from sudden and disruptive redemptions,” the report said.

The potential for a money market fund to suspend or stop redemption requests can cause a greater contagion across the broader economy, according to the report.

“Investors and companies losing their access to their cash holdings in money market funds could subsequently fail to make business-critical payments like margin calls and payroll, among others,” the report said. “This contagion effect can also occur from a money market fund industry that only represents a small percentage of a jurisdiction’s total fund sector.”

In all, the report added, money market funds can cause shocks within the financial system, particularly if their connections to other parts of the financial system or the real economy are pronounced.

The FSB also noted in the report that addressing money market fund vulnerabilities is a crucial part of its work to “enhance the resilience of nonbank financial intermediation.”

This comes as several regulators around the world are calling for greater oversight of the nonbank financial system.

For example, Bank of England Deputy Governor Sarah Breeden earlier this week called for more research into nonbank lenders to prevent a “credit crunch” that could result from a pull-back by hedge funds, pension funds, asset managers and insurers.

“A shift in the willingness of market-based finance to lend to corporates, particularly those perhaps that are highly leveraged, would have significant implications for the real economy — a credit crunch sourced in market-based finance rather than bank lending,” Breeden said during a Bank of England conference.

Meanwhile, the FSB is set to deliver a report to G20 later this year highlighting the influence of social media in accelerating bank deposit outflows and the need for changes to liquidity rules, PYMNTS wrote in January.

The investigation follows the collapse of Silicon Valley Bank in March last year, which was caused by rapid outflows partially fueled by posts on social media.