The European Central Bank and the European Systemic Risk Board have released a joint report examining the financial stability risks arising from connections between EU banks and the non-bank financial intermediation (NBFI) sector.
According to the report, while current linkages do not pose immediate threats, they create vulnerabilities that could amplify financial stress under adverse market conditions. These risks are concentrated in a small number of large euro area global systemically important banks (G-SIBs), whose shock-absorbing capacity is crucial for maintaining stability.
Banks interact with the NBFI sector mainly through liquidity management, the provision of leverage and market-making. The report outlines two key risk channels. First, banks鈥� reliance on short-term funding from NBFIs could become problematic during market turmoil, especially if asset price shocks trigger redemptions and margin calls, leading to a sharp decline in funding. Second, banks鈥� lending to leveraged NBFIs鈥攕uch as hedge funds and securities firms鈥攅xposes them indirectly to risky trading strategies, increasing the likelihood of asset fire sales, market volatility and potential credit losses.
The analysis is based on granular transaction and exposure-level data, but significant data gaps鈥攑articularly regarding exposures and transactions outside the EU鈥攍imit a full assessment of risks. The report calls for improved and more centralized data-sharing mechanisms to strengthen oversight of bank-NBFI linkages.
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