Bank lending to NBFIs crowds out real economy credit

Over the past decade, euro area banks have increasingly shifted lending towards non-bank financial institutions (NBFIs), reaching over €3.1 trillion, or 63 percent of total bank lending to firms.

This ECB working paper, using granular supervisory and loan-level data, documents that a large and growing share of this bank-to-NBFI lending takes the form of reverse repurchase agreements (reverse repos).

These short-term, collateralised loans are typically used by NBFIs like hedge funds and mutual funds to finance government securities, rather than to fund direct loans to non-financial firms.

Consequently, much of this growth in bank-to-NBFI lending does not directly support credit to the real economy.

The study highlights that NBFIs primarily investing in marketable securities are the main drivers of this increased borrowing from banks, rather than NBFIs that extend credit to firms.

The paper finds that bank lending to NBFIs systematically crowds out bank lending to non-financial firms.

Banks expanding exposures to NBFIs reduce corporate lending significantly more than they reduce holdings of other assets.

This substitution is driven by rising NBFI borrowing demand to finance securities positions, particularly due to quantitative tightening and increased government bond supply.

On the supply side, bank capital and liquidity constraints amplify the shift, as loans to NBFIs are safer, more liquid, and carry lower regulatory costs than direct loans to firms.

This reallocation has real effects, with smaller and riskier firms experiencing larger declines in credit and overall debt.