Joint report identifies financial stability vulnerabilities from bank-NBFI linkages
The European Central Bank and the European Systemic Risk Board have published a joint report on financial stability risks from interconnections between banks and the non-bank financial intermediation (NBFI) sector. The report finds these linkages create significant vulnerabilities, particularly for large euro area global systemically important banks.
Significant linkages, concentrated vulnerabilities
The joint report by the European Central Bank (ECB) and the European Systemic Risk Board (ESRB) identifies significant interconnections between EU banks and the non-bank financial intermediation (NBFI) sector.
While these linkages do not currently pose acute risks, they create important vulnerabilities that could amplify stress in adverse market conditions.
These vulnerabilities are highly concentrated in a small number of large euro area global systemically important banks (G-SIBs).
The report highlights that the risk-bearing capacity among these G-SIBs is crucial for absorbing shocks and preventing the amplification of financial stress.
Banks play three key and interlinked roles in their interactions with the NBFI sector: liquidity management, provision of leverage, and market-making.
Funding loss and leveraged lending risks
The report identifies two primary channels for systemic risk.
Firstly, a loss of short-term funding from NBFI entities could challenge banks during market tensions, driven by the funding's short-term nature and provider homogeneity.
Asset price shocks could trigger redemption requests and margin calls, potentially reducing NBFI funding to banks.
Secondly, bank lending to leveraged NBFI entities indirectly exposes banks to their trading strategies and asset price shocks, which could lead to position unwinding and asset fire sales.
The report emphasizes that data gaps, particularly for non-EU exposures, constrain a comprehensive assessment of these risks, highlighting the need for improved information sharing and centralized data access.