How New Liquidity Providers Are Affecting Traditional Banks
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Market liquidity is notoriously difficult to track. Even academics disagree on the best measures, and liquidity indices are often contradictory and volatile. But one aspect of market liquidity is easily measured and is measurably shifting: the source.  

Over the past decade, a new generation of liquidity venues and providers have emerged to disrupt and challenge incumbents across multiple asset classes. New venues like Tradeweb, MarketAxess, and Octaura leverage electronic marketplaces to match supply and demand in traditional over-the-counter markets, while new liquidity providers and proprietary trading firms such as Virtu, Jane Street, and Citadel deploy sophisticated trading strategies across asset classes. 

As the upstarts make inroads, traditional broker-dealers within universal banking groups are being squeezed into narrower roles due to escalating costs. The technology and talent required to compete in quantitative market-making is becoming more expensive — and the cost of holding inventory and the associated capital to support market-making can be prohibitively expensive during periods of market stress. 

The advantages of nonbank liquidity providers

The current trajectory suggests a higher share of volume for nonbank liquidity providers (NBLPs) across asset classes, on traditional and alternative venues as well as direct-to-client interactions. NBLPs are already becoming more dominant in equities, exchange-traded funds, listed equity derivatives, and currencies, and are poised to expand their asset-class coverage to government securities, fixed-income derivatives, corporate credit, and crypto. At the same time, a more interesting and less visible shift has been their push into providing liquidity directly to buyside clients, a head-on challenge to the traditional broker-dealer model at banks. 

NBLPs have a number of advantages. They can hire the talent to identify trading opportunities, quickly deploy new trading technologies and algorithms, and hold the risk required to generate outsized returns. They are supported by the proliferation of new electronic marketplaces and execution protocols and the evolution of the broker-dealer businesses of banks. 

Exhibit 1: US equities trading — volumes dominated by nonbank liquidity providers
Total number of shares traded on exchanges, 2024, size indicative of trading volume
Notes: 2024 US equities trading volumes don’t include shares traded in December 1. Hudson River Trading
Exhibit 2: Banking revenues — banking business model shifts toward prime financing
Banking revenues segmented by type, 2009-2024, $ billions
Liquidity Exhibit
Notes: Cash trading includes listed derivatives (all years) and proprietary trading (2009)
Source: Oliver Wyman analysis, Coalition-Greenwich

However, this is not a zero-sum game for banks. The headlines revenues for NBLPs are misleading. They include both market-making and quantitative investment activity (an area where NBLPs compete with hedge funds, not banks). Banks report clean market-making revenues that strip out the handsome fees they can collect from exchange, brokerage and clearing activities. And the business model for bank-owned dealers has changed over the past 10 years: dealers more often provide financing (and ancillary services) to the risk-takers versus taking the risk themselves. This business will often require more balance sheet and capital, but generate stronger and more stable profits.

Regulatory shifts and threats to bank and NBLP liquidity 

Nevertheless, three surprises over the next four years could shift the current trajectory toward greater and greater liquidity provision by NBLPs across asset classes. Each is a variation on a theme — more balanced regulation of bank’s liquidity provision activities versus those of NBLPs.

1. Tightening regulation for nonbanks

The most extreme scenario is formal designation of individual NBLPs (or entire categories) as systemically important, in the US or elsewhere. Any significant change in the regulatory environment for NBLPs would likely be triggered by a significant market failure, such as a flash crash in one or more asset classes in which liquidity is predominantly provided by nonbank financial institutions (NBFIs). Banks are still seen as safe haven liquidity providers in times of market stress. Policymakers, regulators, and supervisors could take the opportunity to restore the competitive balance between banks and NBLPs in market-making, especially in sensitive asset classes such as US Treasury securities.

2. Limiting leverage for nonbanks

Regulators (in particular those outside the US) have begun to examine the financing services that banks provide to NBFIs over the last 18 months, which could provide a path to indirect monitoring, supervision, and restriction of risk-taking outside the banking system (NBLPs rely on financing from banks to execute their strategies).

3. Adapting the broker-dealer model

Alternatively, major banks could continue to adapt their traditional broker-dealer model to defend high-value trading activities (such as portfolio trading in credit markets) against the encroachment of NBLPs. This is increasingly plausible with the softening of the Basel III Endgame capital requirements.

This article is part of our Known Unknowns report highlighting the debates that will shape the future of financial services