The European Central Bank (ECB) lacks “a full picture of how risk transformation may be occurring” in non-bank financial institutions (NBFIs), says member of Supervisory Board Elizabeth McCaul. In her keynote speech at a recent conference on counterparty credit risk (CCR) management, she notes that there is a danger correlation risks may be developing outside of ECB’s supervisory remit, and emphasises the value of discussions about a broader regulatory framework.
ECB’s “limited line of sight into potential indirect links between banks and non-banks and between non-banks and other non-banks” is only made worse by the opacity of the private equity and private credit markets, says Elizabeth McCaul. “Over the past few years, we observed that the search for yield in a low interest rate environment had incentivised some banks to turn to riskier and less transparent counterparties from the NBFI sector, including hedge funds and family offices.” The lack of oversight of potential correlation risks is a cause for concern, as left unchecked, they could evolve into systemic risks.
“If we are to fully understand the emerging risks and ultimately ensure that market participants are able to address them, sound practices for managing counterparty credit risk should go beyond minimum compliance with regulatory requirements,” she says.
Sound practices
Referring to ECB’s report on sound practices in CCR governance published in October last year, she acknowledges that the authority has been placing “considerable emphasis” on CCR and “will continue to do so”. “We expect banks’ approaches to be proportionate to the scale and complexity of their business, the products they offer and the nature of their counterparties. Banks should remediate shortcomings without undue delay and, given the uncertain geopolitical situation, avoid complacency.”
Based on observations from its supervisory activities, the ECB believes that institutions are “generally moving” towards the sound practices recommended in the report. However, there remain areas of improvement, especially in stress testing, risk metrics, and regular fire drills.
ECB will continue monitoring progress in CCR management, having categorised it as “a supervisory priority” between 2024 and 2026.