Edited by Kern Alexander and Rahul Dhumale
Chapter 1: The Nature of Modern Credit Markets, Banking and Financial Innovation
Kern Alexander, John Eatwell and Avinash Persaud INTRODUCTION For most of modern history the availability of credit has been segmented into two markets: the banking and mutual savings institutions and what may be described as the informal lending sector – a plethora of informal, unregulated direct lending mechanisms (person to person, credit cooperatives, micro lending, and so on). Whilst a significant proportion of retail and small business lending may have gone through the informal markets, the majority of all borrowing and almost all large corporate borrowing has gone through the banking market. As the global capital markets have evolved over the last thirty years a new source of credit has grown exponentially. This is generally referred to as ‘bank disintermediation’. The whole corporate bond market effectively disintermediated the banks by directly pairing off non-bank providers of liquidity with corporate and sovereign borrowers. The banks themselves benefited from the growth of non-bank bond investors by tapping this sector for its own senior and subordinated liquidity needs. Having established a huge investor base of non-bank credit investors, the next step in the bank disintermediation process was to allow assets traditionally funded on bank balance sheets (corporate loans, mortgages, and so on) to be moved into separate companies and be financed by these same non-bank liquidity providers. It was this last development that saw enormous growth in the decade before 2007 as bank loans, bonds, credit derivatives and a growing array of retail asset backed securities (ABSs) were packaged into collateralised debt obligations (CDOs)...
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