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Non-Bank Dealing and Liquidity Bifurcation in Fixed-Income Markets

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  • Michael Brolley
  • David Cimon

Abstract

Non-bank financial institutions, such as principal-trading firms and hedge funds, increasingly compete with bank-owned dealers in fixed-income markets. Some market participants worry that if non-bank financial institutions push out established bank dealers, liquidity will become unreliable during times of stress. We model non-bank entry and state-dependent liquidity provision. Non-bank participants improve liquidity more during normal times than in stress, leading to a bifurcation of liquidity. In the cross-section, their entry improves liquidity for large and previously unserved small clients; however, banks may no longer provide reliable liquidity to marginal clients. Central bank lending may limit harmful bifurcation during times of stress if that lending is predictable and at sufficiently favourable terms.

Suggested Citation

  • Michael Brolley & David Cimon, 2025. "Non-Bank Dealing and Liquidity Bifurcation in Fixed-Income Markets," Staff Working Papers 25-2, Bank of Canada.
    • Handle: RePEc:bca:bocawp:25-2
    DOI: 10.34989/swp-2025-2
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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