Financial intermediation beyond banks: taking a macroprudential approach

28 November 2024

By François Haas, Cornelia Holthausen and Vasileios Madouros^[1]

Since the global financial crisis, a key development in the financial system – globally and in Europe – has been the growing importance of non-bank financial intermediation (NBFI). The NBFI ecosystem, in a broad sense, comprises a diverse set of financial activities, entities and infrastructures beyond banks, including investment funds, family offices, pension funds, insurance companies, and other non-bank entities. It has grown primarily through the asset management sector, and its total assets today are equivalent to more than three times the annual output of the euro area economy.^[2] The non-bank financial sector now plays a key role in financing the economy, making it a valuable complement to traditional bank financing. Overall, increased non-bank financial intermediation, and thus financing via capital markets, can benefit the whole economy. This underpins the EU’s savings and investments union agenda and is the fundamental reason for building a single capital market in Europe.

However, like all forms of financial intermediation, NBFI can carry financial vulnerabilities, which – if left unchecked – can contribute to a build-up of systemic risk. Several factors play into this. Non-bank entities may be exposed to high liquidity risk, for example, due to structural liquidity mismatches or because they may not be well prepared to meet large margin and collateral calls. They can also become excessively leveraged and are often highly interconnected with other parts of the financial system. Vulnerabilities in the NBFI sector can trigger, spread or amplify financial shocks affecting the financial system and real economy. Indeed, in recent years, NBFI vulnerabilities have contributed to disruptions in key financial markets, with adverse implications for the broader financial system, the real economy, and in some cases the transmission of monetary policy. For example, in March 2020, amid a surge in redemption requests by investors, procyclical selling by money market funds and other investment funds with exposures to less-liquid securities led to a severe worsening of liquidity conditions in underlying markets.

To reduce the build-up of systemic risk in the NBFI sector, the current regulatory framework needs to evolve and incorporate a macroprudential perspective for building resilience ex ante. Right now, existing rules for NBFI concentrate mainly on investor protection and market integrity. While these are important policy objectives in their own right, a macroprudential approach takes a different perspective, by focussing on the potential impact that non-banks could have on the broader financial system and the overall economy. As the sector becomes increasingly intertwined with the banking industry, addressing its vulnerabilities would not only make NBFI more resilient, but also limit risks facing the banking sector.

A macroprudential approach for NBFI cannot – and should not – simply seek to copy the approach for the banking sector. Moreover, a “one-size-fits-all” approach would not be effective for non-banks, given the wide range of entities and activities that it covers. Instead, the approach for NBFI should be appropriately tailored, taking into account the diversity of business models in the sector. It should prioritise increasing the sector’s resilience ex ante, by reducing vulnerabilities before risks materialise. And – given the global nature of capital markets – international coordination and consistency are critical to reducing the risk of cross-border fragmentation and regulatory arbitrage.

In this spirit, to gain more insight into the risks and vulnerabilities of non-banks and to seek stakeholders views on how to tackle risk from non-banks to the rest of the financial system and real economy, the European Commission launched a consultation on macroprudential policies for NBFI. In its reply, the Eurosystem set out its views on a macroprudential approach for NBFI.

The Eurosystem’s proposed priorities

Several key factors are essential to develop a macroprudential approach for the NBFI sector in Europe.

First, Europe needs to swiftly implement the international reforms for regulating NBFI that have recently been agreed. This includes reforms to enhance the resilience of money market funds, as well as the Financial Stability Board’s 2023 recommendations to address vulnerabilities from liquidity mismatch in open-ended funds. In addition, new macroprudential tools are needed – complementing the existing toolkit for NBFI – to prevent the rise of systemic vulnerabilities in key parts of the sector. The Eurosystem advocates giving authorities a small number of additional powers to limit liquidity mismatch and leverage in investment funds before risks materialise, to safeguard financial stability.

Second, there should be system-wide stress tests in Europe to identify and quantify risks to the resilience of core markets. These tests would assess how different market participants react to adverse shocks and how their collective actions might affect system-wide risk. Such an exercise would also help to identify remaining data gaps, improve data sharing and encourage better supervisory cooperation across sectors. More broadly, data is essential for identifying potential risks in NBFI. While various authorities across Europe are collecting data at the moment, existing mechanisms for accessing and sharing data are insufficient, limiting authorities’ collective ability to monitor vulnerabilities across the EU financial system. Improving access to relevant data across jurisdictions would help close an important gap in the current framework.

Third, strengthening the macroprudential perspective in the oversight of NBFI requires effective governance arrangements. This can be achieved by enhancing the mechanisms for co-ordination between European and national authorities responsible for macroprudential policy and supervision. Adopting similar macroprudential policy measures across jurisdictions where needed (via reciprocation) should be a key element of this. An additional mechanism to enhance coordination across the EU would be to grant the European Securities and Markets Authority (“top up”) powers to request the implementation of macroprudential measures – in collaboration with national authorities and after consulting with the ESRB – if there is a need to do so.

Finally, since the scope of NBFI regulations is a key element of macroprudential policy, it should be monitored and adjusted wherever needed. This includes improving access to data and assessing risks in asset management activities beyond the traditional focus on regulated investment funds, such as family offices or the delegation of investment decisions via discretionary mandates. It also means addressing systemic risks with a comprehensive approach, incorporating both an entity and activity-based perspective.

Undoubtedly, it will take some time to fully develop a macroprudential approach as described, but it should remain a priority for policymakers, in Europe and internationally. NBFI needs to be resilient to ensure that capital markets can serve as a sustainable source of financing for EU firms, in line with the aims of the savings and investments union. Strengthening the macroprudential lens in the oversight of NBFI will ensure that the regulatory framework remains fit for purpose as the European and global financial system continues to evolve.

For more on this topic, see the Eurosystem response to EU Commission’s consultation on macroprudential policies for non-bank financial intermediation (NBFI).

The views expressed in each blog entry are those of the author(s) and do not necessarily represent the views of the European Central Bank and the Eurosystem.

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