ECB calls on lenders to manage growing risk from shadow banks

Shadow banks are growing quickly across the eurozone and represent a growing risk to the entire financial system, requiring lenders to be more stringent when dealing with such entities, European Central Bank supervisor Andrea Enria said.

Shadow banks, such as investment funds or insurance companies, now have 31 trillion euros (S$45.4 trillion) in assets, equalling 80 per cent of the supervised bank sector, but they are more loosely regulated and often take riskier bets.

“Risks among non-bank financial intermediaries (NBFI) could intensify in coming months as monetary policy continues its effort to bring inflation back to its target,” Enria said on Tuesday (Jun 20), arguing that risks have built up “profoundly”.

Leverage has grown sharply among shadow banks, there is a large mismatch in the duration of their assets and liabilities, and there is evidence of insufficient preparedness to meet large demand for liquidity, Enria warned.

The concern is shadow banks have remained largely unregulated and risks have been allowed to grow largely unchecked, Enria warned.

But shadow banks are closely connected to the more regulated bank sector, so stress there could spread to more traditional lenders, requiring banks to actively manage client risk.

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“Funding from NBFI entities is possibly one of the most significant spillover channels from a systemic risk perspective, given that NBFI entities maintain their liquidity buffers primarily as deposits in banks and interact in the repo markets with banks,” Enria said.

Shadow banks also tend to deal with a small group of systemically important banks, so their stress would likely hit some of Europe’s top lenders.

While new regulation would be ideal, these take time to negotiate and implement, leaving banks vulnerable in the short term.

So for now, the most important safeguard is for banks to be aware of the risks and to actively manage this when dealing with shadow banks, Enria said.

“The key message is that we expect institutions to go beyond mere compliance with regulatory requirements when designing their approaches,” Enria said. REUTERS