The European Banking Authority (EBA) published today its final Guidelines regarding limits on institutions’ exposures to ‘shadow banking entities’ that carry out bank-like activities outside a regulated framework. In particular, these Guidelines introduce an approach that will allow EU institutions to set internal limits for their exposures to ‘shadow banking entities’, hence addressing in a proportionate way the risks that these exposures pose to the EU banking sector. The Guidelines were informed by a Report, also published today, on the exposures of a sample of EU institutions to ‘shadow banking entities’ and the impact of setting limits.
The EBA Guidelines on exposures to ‘shadow banking entities’ will support institutions and banking supervisors across the EU in minimising the risks arising from exposures to entities that carry out bank-like activities outside regulated frameworks. The Guidelines ensure institutions have sufficient information about their shadow banking counter-parties so they can make an informed risk assessment of their exposures and also detail the requirements for institutions to set limits to both individual and aggregate exposures to shadow banking entities. For those institutions that do not have sufficient information on their exposures to shadow banking counter-parties, the EBA requires a fallback approach involving a fixed limit to all or some of these aggregate exposures.
The focus of the Guidelines is on entities that pose the greatest risks in terms of both the direct exposures institutions face and also the risk of credit intermediation outside the regulated framework. For this purpose, ‘shadow banking entities’ are defined as entities that carry out credit intermediation activities (i.e. bank-like activities involving maturity transformation, liquidity transformation, leverage, credit risk transfer or similar activities) without falling within the scope of consolidated supervision (or equivalent third country legal frameworks). In addition, ‘excluded undertakings’, which are subject to an appropriate and sufficiently robust prudential framework, are not to be considered as shadow banking entities.
Isabelle Vaillant, Director of Regulation at the EBA, explained that: “Shadow banking has the potential of putting the stability of the financial system at risk” and reminded how “recent global financial crises have revealed fault lines which were previously unknown, but can transfer risks from the unregulated to the regulated banking system”.
To better understand the relevance of institutions’ exposures to ‘shadow banking entities’, the EBA conducted a data collection, the first of this kind in the EU, on a sample of 184 EU institutions (169 credit institutions and 15 investment firms) in 22 Member States. The data included in the Report shows that that institutions’ total exposures towards shadow banking counterparties (as defined in the Report) account for 1.082.209 million EUR and for large and internationally active banks, they represent, on average and in aggregate terms, up to 45% of their eligible capital.
The EBA Guidelines will apply as of 1 January 2017 and, together with the Report, will inform the European Commission’s work in relation to its upcoming report on the appropriateness and impact of imposing limits on exposures to shadow banking entities.
BACKGROUND AND LEGAL BASIS
The Guidelines have been developed in accordance with Article 395(2) of the Capital Requirements Regulation (CRR), which mandates the EBA to set limits on exposures to shadow banking entities.
The term ‘shadow banking entities’ has been defined in line with the previous EBA Opinion and Report on the perimeter of credit institutions and aims at capturing entities that are not subject to any prudential regulation and supervision equivalent to banking regulation.
The definition of ‘shadow banking entity’ used in the EBA report is broader than the definition used in the Guidelines, to capture as much information as possible and inform future work on this topic. Participating institutions were asked to report all exposures to individual ‘shadow banking entities’ (as defined in the EBA report), or at least exposures with a value equal to or in excess of 0.25 % of the institutions’ eligible capital, after large exposures’ exemptions and credit risk mitigation.
Shadow banking entities tend to be more vulnerable to liquidity problems, while remaining very interconnected to the banking sector, hence leading to financial stability concerns. Shadow banking entities are generally not subject to the same standards of prudential regulation as normal banking institutions. They do not have access to central banks’ liquidity facilities and cannot provide protection to investors’ investment in case of their failure.
Exposures to shadow banking entities carrying out bank-like activities may be inherently risky and also lead to regulatory arbitrage and drive migration of banking activity from the regulated sector ‘into the shadows’.