ECB warns about financial risk coming from shadow banks

FRANKFURT: The European Central Bank is particularly concerned about financial stress spreading from non-bank financial firms to regular lenders in periods of market stress, ECB supervisor Sharon Donnery said on Thursday.

Non bank financial intermediaries, often called shadow banks, have grown in size over the past several but face laxer regulation and also lack access to central bank liquidity facilities, leaving them more vulnerable during sharp market movements.

“As we saw in the past few days, the potential for abrupt asset price corrections remains significant due to geopolitical uncertainties,” Donnery said in a speech.

“As non-banks may be among those to feel geopolitical stress, their interlinkage with banks is a particular concern,” Donnery added.

While the ECB has said that banks handled the past week’s extreme volatility with relative ease, Donnery’s comments suggest concern beyond institutions supervised by the ECB, such as hedge funds or other investment funds.

The issue is that banks often have direct exposures to non-banks through lending and investment activities, making them susceptible to shocks originating within the non-bank sector, Donnery argued.

“The complexity and opacity of some activities in the non-bank sector can further obscure risk concentrations, complicating banks’ risk management efforts,” she said.

Donnery called on lawmakers to firm up the regulatory framework, targeting liquidity mismatches in money market and open-ended funds and strengthen the liquidity preparedness.