Shadow bank funding creates risks for big eurozone lenders, warns ECB

The largest eurozone lenders are exposed to “spillovers” of stress from outside the banking system, relying on so-called shadow banks for more than 15 per cent of their funding, the European Central Bank has warned.

The rapid growth of shadow banks — a group that includes insurers, hedge funds, asset managers and pension funds — since the 2008 financial crisis has left eurozone lenders increasingly vulnerable to “liquidity, market and credit risks”, the ECB said on Tuesday.

Researchers at the central bank found the 13 largest banks in the eurozone account for about 80 per cent of all borrowing from shadow banks, or non-bank financial intermediaries (NBFI).

“Any turmoil in the NBFI sector is likely to disproportionately affect large, complex, systemically important banks, as asset exposures, funding linkages and derivative exposures are concentrated in this group,” the officials said.

Global financial regulators have become concerned that rising interest rates and falling asset prices in areas such as commercial real estate could cause serious stress among shadow banks, which are more lightly regulated than lenders.

Luis de Guindos, vice-president of the ECB, last week proposed several ways to clamp down on rising risks at shadow banks, which he warned had left EU regulation “ever more insufficient” to prevent further financial market shocks from triggering a wider liquidity crisis.

These concerns have increased since family office Archegos Capital Management collapsed in 2021, having suffered heavy losses after making risky bets on financial markets.

The biggest risk identified by the ECB, which examined the connections between 80 lenders and NBFIs, was that funding could be pulled from the banking system at times of stress.

“Although small relative to retail and corporate deposits, deposit funding from NBFI entities can be particularly vulnerable to changes in market conditions,” the researchers said.

Another channel of potential risk transmission is via banks’ derivative trading, a fifth of which they do with shadow bank entities.

Loans and other exposures to shadow banks account for about 9 per cent of the total assets of eurozone banks, the ECB said. But it added that many shadow banks were related to banks through partial ownership or sponsorship of special-purpose vehicles.

Shadow banks also hold about 28 per cent of all debt securities issued by eurozone lenders. 

The report came as the ECB separately published monthly data showing how bank lending in the eurozone continues to be squeezed by higher interest rates and concerns about rising risks. 

Overall bank lending to eurozone households grew at an annual rate of 2.6 per cent — the lowest monthly rate for six years. Business lending grew at an annual rate of 3.8 per cent — the slowest pace for more than a year.

Bank deposits continued to decline, albeit at a slower pace with a monthly outflow of €18bn, as outflows of overnight deposits were partly offset by inflows of money into fixed-term deposits of up to two years.