ECB and ESRB publish joint report on financial stability risks from bank and non-bank sector linkages

The European Central Bank (ECB) and the European Systemic Risk Board (ESRB) 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 roles can lead to systemic risks through two main channels:

• Funding risk: Loss of NBFI funding could challenge banks during market tension due to short-term funding, homogeneous providers, and limited substitution options. Asset market shocks may trigger redemptions and margin calls, reducing NBFI funding to banks.
• Leverage and asset risk: Lending to leveraged NBFI entities exposes banks to trading strategies and asset shocks, potentially causing unwinding of positions, fire sales, and credit losses. Long-term illiquid asset investments are also vulnerable to shocks.

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