The ECB urges reforms to face the risks of ‘shadow banking’

For now, the euro zone has overcome the financial turmoil that this spring has hit US regional banks and Credit Suisse. Frankfurt maintains that the European sector is solid and points the other way. Specifically, the call shadow banking, a constellation of pension or high-risk funds whose expansion has been constant in the last decade. This growth has made it possible to have more business financing, but it has brought new risks. Faced with these threats, the European Central Bank (ECB) urges European leaders to take action. “The lack of political action today can mean the materialization of risks tomorrow,” warned the vice president of the institution, Luis de Guindos.

Europe had traditionally lacked a parallel banking system that would reduce its high dependence on the banking sector. Since the 2008 crisis, however, the funds began to provide more capital to companies. Together, the portfolios of all these instruments have doubled in size since then, from €15 trillion to €31 trillion. This was reflected in the financing of companies: according to the ECB, the credit granted by the shadow banking it went from representing 15% to 26% at the end of last year. “The increased role of non-banks offers the advantage of diversifying funding sources and can therefore help ensure smooth funding for the real economy,” Guindos said at a conference in Frankfurt.

However, it also opens up new cracks through which a financial crisis can slip through. The bankruptcy of the Archegos fund amply demonstrated this. And it was revealed again by the crisis that the United Kingdom went through in the autumn, when the tax cut plans of former Prime Minister Liz Truss worried the markets. The funds collapsed when UK bond yields soared, fund depositors began selling and the funds found themselves unable to respond having invested in illiquid assets. “The strong growth of the non-bank financial sector, especially the asset management industry, over the last 15 years has been accompanied by an increase in liquidity mismatches,” warned the number two of the ECB.

community regulation

The fact that investors in these funds can demand their money without prior notice, according to Guindos, makes them more vulnerable and creates more pressure on the demand for liquidity. This, he has said, has become “more procyclical.” In other words, it increases in periods of tension in the financial markets. The vice president of the ECB has given the pandemic period as an example, when these fund imbalances increased liquidity needs and “amplified the stress in the financial markets.” “There are no reasons for complacency,” added Guindos, who has warned that structural vulnerabilities due to liquidity mismatches and leverage “remain high despite the recent reduction in risk.” “Bank and non-bank financial institutions can be closely interconnected through common funding channels, ownership ties, and risk exposures,” he added.

Guindos has urged reforms to limit risks. First, to require these entities high levels of liquidity in the event that they allow withdrawal of funds on a daily basis. It has also called on European leaders to prioritize reform of the money market fund sector and to improve the “quality and coverage of data and information sharing” to assess the leverage risks of these funds. “The lack of political action today can mean the materialization of risks tomorrow. In particular, a more comprehensive macroprudential framework should be a priority to ensure that non-banks are more resilient and able to provide a stable source of financing to the real economy in both good and bad times”, Guindos stressed. .

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