Publication - Shadow banking in the euro area: risks and vulnerabilities in the investment fund sector
Copyright 2016, European Central Bank
Non-technical summary
The size and role of the euro area shadow banking sector within the euro area and global financial system has increased. According to a broad measure covering financial institutions other than banks, insurance corporations and pension funds, the financial assets held or managed by the sector in the euro area have doubled over the past decade (to reach nearly EUR 28 trillion in December 2015) and account for over a third of the euro area financial system.
However, this broad measure may overstate the size of the euro area shadow banking sector as it includes entities such as special financial institutions and holding companies, which may not engage in shadow banking activities. More detailed statistics for investment funds (IFs), financial vehicle corporations (FVCs) and money-market funds (MMFs) allow a closer monitoring of balance sheet developments within a more narrowly defined shadow banking sector. With assets totalling over EUR 13 trillion, IFs, FVCs and MMFs account for over half of the broad shadow banking sector. Their assets have grown by more than 40% from the end of 2009 to the end of 2015.
This strong growth has been driven by a rapid expansion of the non-money market investment funds (non-MMF IF) industry. While FVCs and MMFs have struggled to cope with the collapse in demand for securitised products and the low yield environment respectively, inflows to non-MMF IFs have been substantial amid an intense search for yield among global investors. During the crisis years, shadow banks, notably investment funds, have acted as an important buffer for the real economy as bank credit to the private sector contracted. In addition, their increasing role within the financial system has meant that the distribution of risk exposures has become wider.
However, the expansion of the sector also may present systemic risks that need to be detected, monitored and managed. Similar to financial intermediation activities of banks, credit intermediation by this sector involves maturity and liquidity transformation and the use of leverage. However, unlike banks, these entities do not have access to central bank liquidity. The shadow banking sector is highly interconnected with euro area banks and an important source of credit for euro area non-financial corporates (NFCs). Therefore, difficulties in the sector can propagate quickly to the banking sector and the real economy.
Among the main vulnerabilities within the sector, the growing liquidity mismatch within the investment fund sector is a key concern. Open-end funds add to the illusion of stable liquidity conditions by promising daily callable claims to purchase assets which may not be very liquid in a period of market repricing. While most euro area funds offer daily redemption to investors, their cash buffers and shares of liquid and short-term assets have been falling. This increases the sector’s vulnerability to large-scale redemptions and raises the risk of an adverse liquidity spiral1 .
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