EBA issues guideline limits on shadow banking

The European Banking Authority has issued new guidelines on limits to credit intermediaries which operate beyond the scope of regulation, effective as of 1 January 2017.

The European Banking Authority has issued its final guidelines for institutions with exposure to shadow banking entities.

The guidelines aim to support institutions and banking supervisors across the European Union in minimising the risks arising from exposures to entities that carry out bank-like activities outside regulated frameworks. UCITS funds, other than money market funds, and alternative investment funds that meet certain requirements are excluded from the scope of the guidelines.

Institutions are tasked with identifying their own limits according to an approach called the ‘principal approach’. If institutions are not able to apply the approach, the EBA has directed them to use a fall back approach, in accordance with an article of EU regulation no. 575/2013.

The EBA defines shadow banking as entities that carry out credit intermediation such as bank-like activities involving maturity transformation, liquidity transformation, leverage, credit risk transfer or similar activities, which do not fall within the scope of consolidated supervision.

“Shadow banking has the potential of putting the stability of the financial system at risk”, Isabelle Vaillant, director of regulation at the EBA, said in a statement.

“Recent global financial crises have revealed fault lines which were previously unknown, but can transfer risks from the unregulated to the regulated banking system”, she added.

However, the EBA acknowledged in its report that many of the flaws in the way that such institutions previously operated have “since vanished as markets and institutions have reacted”.

The EBA raised three concerns though. The first was that there is a potential danger that the overall regulatory regime applied to regulated banks might give non-regulated entities a competitive advantage. It also said that regulatory agencies should have a common definition of what is meant by ‘shadow banks’ and that regulation should be applied consistently between countries. Thirdly, the proposed rules may have the unintended consequence of undermining the fluidity of securitisation schemes currently proposed under the Capital Market Union, it said.

The EBA conducted a data collection, the first of its kind in the EU, on a sample of 184 EU institutions – 169 credit institutions and 15 investment firms – in 22 member states.

Total exposure to shadow banking counterparties accounts for roughly €1 trillion, the EBA said. For large and internationally active banks, they represent up to 45 percent of their eligible capital.

According to the results, only slightly more than 10 percent of the exposure amounts are to entities which are known to be supervised. Turning specifically to the treatment of funds, these tend to engage in maturity and liquidity transformation and are generally regarded as outside of the traditional banking sector, albeit some are regulated, the EBA said.

Based on the results, the proportion of amounts of exposures to money market funds is less than 5 percent. Around one quarter is to non-MMF investment funds, of which one fifth is hedge funds.

The new guidelines will apply from 1 January 2017. The European Commission will use the information in an upcoming report on the appropriateness and impact of imposing limits.

The EBA was unavailable for further comment at the time of publication