Systemic risks in linkages between banks and the non-bank financial sector

Linkages between euro area banks and entities in the non-bank financial intermediation (NBFI) sector may lead to the emergence of systemic risk in at least two fields. First, the banking sector receives short-term deposit, repo and debt securities liabilities from NBFI entities. Such liabilities may be prone to flight risk and difficult to substitute. Second, euro area banks provide credit to NBFI entities which follow leveraged investment strategies. Hedge funds, mainly based outside of the euro area, together with non-bank lenders and real estate funds are the main groups of such leveraged NBFI entities. These interconnections are particularly important for euro area global systemically important banks (G-SIBs), which play a central role in financial intermediation and transform short-term NBFI liabilities into credit granted to other NBFI entities. While the scale of these linkages is generally contained, they could make euro area banks vulnerable to asset price shocks which, by triggering NBFI funding outflows and counterparty credit losses on exposures to NBFI entities, could lead to deleveraging by banks, reduced provision of leverage by banks to NBFI entities and asset fire sales. G-SIBs’ loss-absorbing capacity is thus essential to ensure the smooth provision of financial services in times of stress. JEL Classification: G21, G22, G23, G24