The Growing Risk of Shadow Banks to Eurozone Lenders
Eurozone lenders are at risk of significant exposure to non-bank financial intermediaries (NBFIs) or shadow banks, according to the European Central Bank (ECB). Shadow banks, which include pension funds, insurers, hedge funds, and asset managers, have rapidly grown since the 2008 financial crisis, accounting for over 15% of funding of large banks in the Eurozone. The ECB warns that the increased exposure of Eurozone banks to shadow banks makes them highly susceptible to “liquidity, market, and credit risks.” Furthermore, the 13 largest banks in the Eurozone account for 80% of lending from shadow banks or NBFIs, making them disproportionately affected in case of any turbulence in the NBFI sector.
Risks Tied to Shadow Banking
The global financial regulators have become interested in the rising risks facing shadow banks due to the potential fallout from interest rate increases and falling asset prices in areas like commercial real estate. However, the risks tied to shadow banking have been increasing since the collapse of Archegos Capital Management, which took heavy losses after making risky bets in the financial markets. Although the shadow banks’ deposit funding is relatively small compared to retail and corporate deposits, it remains vulnerable to changes in market conditions.
The ECB warns that another potential risk transmission channel is through banks’ derivatives trading, leading to a fifth of exposure to shadow bank entities. Shadow banks hold approximately 28% of all debt issued by Eurozone lenders, and loans and other exposures to shadow banks account for about 9% of total assets of Eurozone banks.
Proposals to Quell the Risks
The Vice-President of the ECB, Luis de Guindos, has proposed several ways to quell the growing risks of shadow banks. He warns that EU regulation has become “increasingly insufficient” and calls for stronger regulations to prevent further financial market shocks from triggering a broader liquidity crisis. Although many shadow banks are tied to the banks through partial ownership or sponsorship of special vehicles, Guindos proposes enforcing stricter regulations to ensure the banking system’s resilience.
Monthly Eurozone Data
EU banks continue to suffer due to increasing interest rates and rising risks, according to monthly data published separately by the ECB. Overall bank lending to Eurozone households grew at an annual rate of 2.6%, the lowest monthly rate in six years. Business loans grew at an annual rate of 3.8%, the slowest rate over a year. Bank deposits experienced significant outflows, posting a monthly outflow of €18 billion, with overnight deposit outflows partly offset by money inflows into fixed-term deposits of up to two years.
Summary:
The ECB warns that Eurozone lenders have a growing risk of exposure to non-bank financial intermediaries (NBFIs) or shadow banks, accounting for over 15% of the funding of large banks in the Eurozone. The rapid growth of shadow banks, including insurers, hedge funds, asset managers, and pension funds since the 2008 financial crisis, poses significant risks to Eurozone banks in liquidity, market, and credit areas. The global financial regulators are becoming interested in rising interest rates and falling asset prices’ possible fallout in commercial real estate. Furthermore, the Vice-President of the ECB has proposed enforcing stricter regulations to prevent financial shocks from triggering a broader liquidity crisis.
Additional Piece:
The risks of shadow banking on Eurozone lenders highlight the challenges of maintaining financial stability in a highly interconnected and complex system. The rapid growth of the shadow banking sector since the 2008 financial crisis has challenged the conventional banking system’s resilience, spreading the risks across the financial system. This situation could be more challenging due to the shifting landscape of financial technology and the rise of digitalization.
Moreover, the regulatory framework of the global financial system needs to adapt to the evolving risks posed by the shadow banking sector. Today, shadow banking intermediation is no longer restricted to traditional intermediaries such as money market funds or collateralized debt obligations, but it has expanded to digital and technological platforms that perform the core functions of the traditional banking system. These platforms are evolving rapidly, presenting new challenges to the current regulatory framework that depends on dealing with traditional institutions.
The regulatory gaps and differences that exist across countries make it easier for shadow banking activities to shift across borders, thereby reducing the ability of individual regulators to manage the emerging risks. Therefore, there is an urgent need for international regulatory coordination to identify and mitigate the risks posed by shadow banking activities.
It is worth noting that there is always a fine line between ensuring financial stability and suppressing the innovation and competition that could benefit the financial system and the economy at large. Therefore, regulators need to strike a delicate balance between ensuring financial stability and promoting healthy competition and innovation.
In conclusion, the risks posed by shadow banking to Eurozone lenders highlight the broader challenges facing the global financial system. The regulatory framework needs to adapt to the evolving risks posed by shadow banking activities, including digital and technological platforms. More importantly, there is a need for international regulatory coordination to manage the emerging risks and strike a delicate balance between ensuring financial stability and promoting innovation and competition.
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The euro zone’s largest lenders are exposed to “spill-out” of stress from outside the banking system, relying on so-called shadow banks for more than 15% of their funding, the European Central Bank has warned.
The rapid growth of shadow banks – a group that includes insurers, hedge funds, asset managers and pension funds – since the 2008 financial crisis has made eurozone lenders increasingly vulnerable to “liquidity, market and credit risks,” according to the ECB She said on Tuesday.
Central bank researchers found that the 13 largest eurozone banks account for around 80% of all lending from shadow banks or non-bank financial intermediaries (NBFIs).
“Any turbulence in the NBFI sector is likely to disproportionately affect large, complex and systemically important banks, as asset exposures, funding linkages and derivatives exposures are concentrated in this group,” they said. officials said.
Global financial regulators have become interested that rising interest rates and falling asset prices in areas such as commercial real estate could cause severe stress among shadow banks, which are more lightly regulated than lenders.
Luis de Guindos, vice president of the ECB, last week proposed several ways to quell the growing risks at shadow banks, which he warned had made EU regulation “increasingly insufficient” to prevent further financial market shocks from triggering a broader liquidity crisis.
These concerns have increased since family office Archegos Capital Management collapsed in 2021, after suffering heavy losses after making risky bets on the financial markets.
The major risk identified by the ECB, which examined the connections between 80 lenders and NBFIs, was that funding could be withdrawn from the banking system in times of stress.
“Although small compared to retail and corporate deposits, deposit funding by NBFI entities may be particularly vulnerable to changes in market conditions,” the researchers said.
Another channel of potential risk transmission is through banks’ derivatives trading, a fifth of which they do with shadow bank entities.
Loans and other exposures to shadow banks account for about 9% of total assets of eurozone banks, the ECB said. But he added that many shadow banks were tied to the banks through partial ownership or sponsorship of special vehicles.
Shadow banks also hold around 28% of all debt issued by eurozone lenders.
The report was published separately by the ECB monthly data showing how bank lending in the eurozone continues to be squeezed by higher interest rates and concerns about rising risks.
Overall bank lending to eurozone households grew at an annual rate of 2.6%, the lowest monthly rate in six years. Business loans grew at an annual rate of 3.8%, the slowest pace for over a year.
Bank deposits continued to decline, albeit at a slower pace with a monthly outflow of €18 billion, as overnight deposit outflows were partly offset by money inflows into fixed-term deposits of up to two years.
https://www.ft.com/content/915d282a-57af-4e6f-bef0-80fab0c9d117
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