ECB calls on banks to manage growing shadow banking risk
Shadow banks are growing rapidly across the euro area and pose an increasing risk to the entire financial system, requiring the financial sector to be tougher in dealing with such entities, European Central Bank supervisor Andrea Enria said.
Shadow banks, such as investment funds or insurance companies, now have €31 trillion ($33.9 trillion) in assets, equivalent to 80% of the supervised banking sector, but they are more laxly regulated and often take riskier bets.
“Risks among non-bank financial intermediaries could intensify in the coming months as monetary policy continues its effort to bring inflation back to target,” Enria said Tuesday, arguing that risks have built up “profoundly.”
Leverage has risen 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 cope with a large demand for liquidity, Enria warned.
The concern is that shadow banks have remained largely unregulated and risks have been allowed to grow largely unchecked, Enria warned.
But shadow banks are closely related to the more regulated banking sector, so strains there could spill over to more traditional banks, forcing banks to actively manage customer risk.
“Non-bank funding is arguably one of the most significant contagion channels from a systemic risk perspective, given that non-banks hold their liquidity buffers primarily as deposits with banks and interact in ‘repo’ markets with banks,” Enria said.
Shadow banks also typically deal with a small group of systemically important banks, so their stresses would likely affect some of the major European banks.
While new regulation would be ideal, it takes 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 actively manage them when dealing with shadow banks, Enria said.
“The key message is that we expect banks to go beyond mere compliance with regulatory requirements when designing their approaches,” Enria said.