Non-bank financial institutions and the functioning of government bond markets

BIS Papers  |  No 119  | 
17 November 2021

The structure of market making in government bond markets has shifted from a bank-centric model to a hybrid one in which non-bank financial institutions, notably principal trading firms and hedge funds, play an important role alongside banks. This shift has occurred in several countries and, while farthest advanced in liquid segments, is also evident in less liquid segments. The turmoil in March 2020 highlighted structural vulnerabilities arising from the hybrid model and the procyclical behaviour of some non-bank financial institutions. Proposals for improving the resilience of liquidity in government bond markets aim to reduce demand for liquidity during stress episodes, increase intermediation capacity and improve the efficiency of intermediation.

JEL classification: G15, G23, G28.

Keywords: financial intermediation, market liquidity, leverage, hedge funds, principal trading firms, government bonds.