Same size, opposite risk: how MMFs flip during equity booms
A new Bank for International Settlements working paper investigates the systemic risk contribution of 3,500 Money Market Funds (MMFs) in the US from 2004 to 2022. The study finds that MMF characteristics significantly influence systemic risk, particularly during asset price bubbles.
MMF size and type matter for systemic risk
The research, utilizing advanced bubble detection techniques and granular fund-level data, reveals that large MMFs and government MMFs (investing exclusively in US Treasury securities) are associated with reduced systemic risk.
Conversely, prime MMFs contribute to higher systemic risk.
Specifically, a one-standard-deviation increase in MMFs' log asset size is linked to an 11.7 basis-point decrease in ∆CoVaR, indicating lower financial fragility in normal times.
However, during equity booms, the same increase in size corresponds to a 5.68 basis-point rise in ∆CoVaR, signaling higher systemic risk at a one-month horizon.
The study also notes that USD-denominated MMFs domiciled offshore show no significant difference in systemic risk contribution compared to their US-domiciled counterparts.
Filling a gap in non-bank financial research
While extensive research exists on asset price bubbles and systemic risk in the macroeconomy and banking sector, non-bank financial intermediaries (NBFIs) have received less attention despite their growing importance.
NBFIs now account for nearly 50 percent of the global financial system.
MMFs, as a core component of the non-bank sector, are particularly relevant due to their bank-like characteristics, perceived substitutability for bank deposits, and their role as a source of financial stress in past crises, including 2008 and 2020.
The paper employs the Backward Supremum Augmented Dickey Fuller (BSADF) test for bubble detection and ∆CoVaR as its primary systemic risk measure, with results robust to alternative measures like Marginal Expected Shortfall (MES).
Policy implications for market exuberance
This study provides crucial empirical evidence on MMFs' systemic footprint, highlighting the need for nuanced regulatory approaches.
While MMF growth is generally benign, policymakers must closely monitor their expansion during periods of market exuberance.
Integrating MMF growth into systemic risk monitoring frameworks is essential to enhance financial stability beyond traditional banking oversight.