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Euro zone’s shadow banks face risk of margin calls, ECB says

by Staff GBAF Publications Ltd
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Euro zone’s shadow banks face risk of margin calls, ECB says

FRANKFURT (Reuters) – Euro zone shadow banks face the risk of receiving large margin calls or client redemptions they cannot meet because they do not have enough cash on hand, the European Central Bank (ECB) said on Wednesday.

The warning was part of the ECB’s twice yearly Financial Stability Review, in which it said the outlook for banks, funds and companies, particularly in real estate, remained “fragile” as high interest rates took an increasingly hefty toll on the economy.

The ECB said liquidity buffers among shadow banks – an umbrella term for funds, insurers and other non-bank financial intermediaries (NBFI) – were “very low”, exposing them to the risk of running out cash at times of market stress.

“Given that liquidity buffers in the NBFI sector remain very low, sudden investment fund outflows, large margin calls or lapsing insurance policies could lead to forced asset sales, which would amplify downward pressures in financial markets,” the ECB said.

In particular, the ECB found many bond funds did not have enough liquid assets to withstand 30 days of severe outflows, with the proportion highest among high-yield and emerging-markets funds.

Insurance companies and pension funds (ICPF) that use derivatives could be exposed to the risk of “large margin calls”, the ECB added, citing those suffered by their UK peers last year as a precedent.

“Any sharp increase in sovereign bond yields or a spike in financial market volatility could expose those ICPFs which use interest rate derivatives to large margin calls,” the ECB said.

The central bank reiterated its call for introducing regulation for shadow banks like the one that governs traditional lenders, including liquidity requirements and stress tests.

In addition, it said funds that invest in real estate should not offer clients daily redemptions and fund managers who invest in assets that become illiquid in times of stress, such as credit, should also consider longer notice periods.

(Reporting by Francesco Canepa; Editing by Mark Potter)