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Funding from NBFI entities would appear to be the most likely and strongest spillover channel, given that NBFI entities maintain their liquidity buffers primarily as deposits and very short-term repo transactions with banks. At the same time, direct credit exposures are smaller and are often related to NBFI entities associated with banking groups. Links with NBFI entities are highly concentrated in a small group of systemically important banks, whose sizeable capital and liquidity buffers are essential to mitigate spillover risks.
The elevated vulnerabilities in the NBFI sector, which have been flagged repeatedly in previous issues of the FSR, raise questions about the risk of spillovers to the euro area banking sector. Since the global financial crisis, growth in the euro area NBFI sector has far outstripped growth in its banking sector.[1] This trend has been beneficial in that it has led to a diversification of sources of finance in the economy, although the NBFI sector is marked by material liquidity and leverage risks. Banks have maintained their central role in financial markets as the main market-makers, clearing counterparties and gateways for NBFI entities. Recent episodes such as the failure of Archegos Capital Management have been idiosyncratic and largely contained, but they show that spillovers from such entities to banks may be material. This special feature examines the linkages which enable financial stress to be transmitted from the NBFI sector to banks, starting with asset-side exposures and funding dependencies, and followed by linkages in the derivatives markets and indirect linkages through overlapping securities portfolios.[2] The special feature identifies exposure concentrations and ranks the spillover channels in terms of their systemic relevance.
Banks’ asset exposures to NBFI entities are considerable and, on average, account for about 9% of significant institutions’ total assets. These asset-side exposures consist primarily of loans, with securities playing a more limited role (Chart B.1, panel a). The credit risk associated with these exposures tends to be low, thanks to the large share of collateralised lending in the loan exposure and investment grade-rated instruments in the securities holdings. Over the past three years, banks’ loans to NBFI entities and holdings of securities issued by NBFI entities have increased materially, even if at a slower pace than total assets. Large banks are more strongly linked to NBFI entities, as 80% of funding and about 90% of asset exposures are concentrated in fewer than 20 banks (Chart B.1, panel b).