ECB and ESRB publish report on financial stability risks from bank and non-bank interconnections

The European Central Bank (ECB) and the European Systemic Risk Board (ESRB) have published a joint report titled “Financial stability risks from linkages between banks and the non-bank financial intermediation sector”.

The report finds that linkages between banks and the non-bank financial intermediation (NBFI) sector are significant and could create vulnerabilities that amplify stress during adverse market conditions. These vulnerabilities are concentrated in a small number of large euro area global systemically important banks (G-SIBs).

The report identifies three key roles played by banks in their interactions with NBFI: liquidity management, provision of leverage, and market-making. These interactions may lead to systemic risks through two main channels:

• Funding challenges: Loss of funding from NBFI entities could challenge banks during market tension due to the short-term nature of such funding, homogeneous funding providers, and limited substitution options. Price shocks could trigger redemptions and margin calls, potentially reducing NBFI funding to banks.
• Leverage and asset shocks: Lending to leveraged NBFI entities exposes banks to NBFI trading strategies. Borrowing via repo and leverage for short-term trading can lead to asset fire sales and market volatility, increasing risks for banks and NBFI. Lending to NBFIs holding illiquid long-term assets also poses credit risk in case of shocks.

The report emphasizes the importance of granular transaction and exposure data to understand these linkages. However, data gaps, especially outside the EU, limit risk assessment. Improved data sharing mechanisms are recommended to address these issues.