30 November 2012

DG ECFIN: Non-bank financial institutions - Assessment of their impact on the stability of the financial system

This study paper examines how non-bank financial institutions (in particular money market funds, private equity firms, hedge funds, pension funds/insurance undertakings, central counterparties, UCITS/ETFs) have performed over the last decade and during the financial crisis.

The report addresses the risks run by each of this type of institutions (credit, counterparty, liquidity, redemption, and fire sales risk), and highlights also the risks arising from a number of activities frequently undertaken by these institutions, in particular securitisation (a.o. agency risk), securities lending (a.o. counterparty risk) and repos (a.o. liquidity risk).

Finally, the report provides a selected overview of approaches for the measurement of financial instability and financial distress. It focuses on tools that have been developed for banks and that may be usefully applied to non-bank financial institutions in the future. The tools can be broadly grouped into five categories, namely (i) indicators of financial distress based on balance-sheet data, (ii) early-warning indicators, (iii) macro stress tests, (iv) methods for calculating the systemic importance of individual institutions, and (v) analyses of interconnectedness. However, the review of available non-bank financial institutions' data undertaken by the study and the discussions with stakeholders (about 30 non-bank financial institutions were surveyed for this study) identified a number of major data gaps, which, at the present time, preclude transposing the analysis undertaken so far for the banking institutions to the non-bank financial institutions.

Based on the findings from the literature and taking into account the limited range of relevant data, the study recommends that the following key risk-contributing factors should be regularly monitored as part of a broader risk monitoring system for both the various non-bank financial institutions segments and individual non-bank financial institutions:

(i) an indicator of the appetite for risk-taking (e.g. rate of growth of the balance sheet items),

(ii) an indicator of leverage,

(iii) an indicator of liquidity risk, and

(iv) an indicator of maturity mismatch.

Missing from the set of indicators listed above are indicators related to credit and market risk. The sectoral and sub-sectoral data which are currently available are too aggregated to be able to construct credit and market risk indicators. While the annual statements and reports published by public financial institutions provide often information of the credit and/or market risk of a range of assets on their books, such information is typically available with a considerable lag so as to make it largely useless in a rapidly evolving financial environment. Missing is also an indicator of interconnectedness as, at the present time, the publicly available information can only be analysed at a very aggregate level and provides only a picture, from the banking sector's perspective, of the connectedness of the latter with non-bank financial institutions but not, from the non-bank financial institutions’ perspective, of connectedness of non-bank financial institutions with themselves or with the banking institutions.

Link to full study paper

© European Commission