Non-bank financial intermediaries as providers of funding to euro area banks

Prepared by Emanuele Franceschi, Christoph Kaufmann and Francesca Lenoci

Published as part of the Financial Stability Review, May 2024.

Around 20% of euro area banks’ funding is provided by the non-bank financial intermediation (NBFI) sector. Compared with usually more stable retail sources, NBFI funding mainly consists of market-based instruments, such as bonds and repurchase agreements, with the latter being particularly sensitive to stress events.^[1] Leveraging on previous analysis,^[2] this box investigates the role of the NBFI sector in providing funding to banks. In this context, the analysis assesses risks to banks in the event of sudden outflows from the NBFI sector with potential knock-on effect on their ability to finance banks. Specifically, we evaluate whether banks can replace their NBFI funding by tapping different instruments or sectors.

Chart A

The share of NBFI funding has increased since 2021, driven by more bond issuance and repo financing

a) Share of funding from the NBFI sector, by bank business model	b) Cumulative changes in euro area banks’ liabilities and share of funding from the NBFI sector
(Q1 2021-Q3 2023, percentages)	(2021-23; left-hand scale: € trillions, right-hand scale: percentages)

The importance of NBFI funding varies with banks’ business models. Investment banks and banks specialised in corporate and wholesale lending often receive about one-third of their funding from NBFI entities (Chart A, panel a). Universal and diversified banks – which dominate the euro area banking sector – and smaller retail banks receive between 5% and 10% of their funding from the NBFI sector. Banks which depended significantly on NBFI funding in 2021 have tapped this source even more over the last two years, while smaller banks further reduced their initially low exposure. In aggregate, the importance of non-bank funding has increased over recent years, with a reduction in central bank funding being partially offset by issuing bonds and borrowing from NBFI entities on secured money markets (Chart A, panel b).

NBFI sectors feature preferred habitats for different asset classes and maturities, leading to a limited degree of substitutability across sectors and funding instruments. Insurance corporations and investment funds hold sizeable amounts of long-term debt securities issued by euro area banks (Chart B, panel a).^[3] Other financial institutions and investment funds provide short-term secured funding on repo markets, while money market funds hold large amounts of banks’ commercial paper and certificates of deposit. The concentration by funding source reflects different business models, investment mandates and maturity profiles in NBFI sectors.

Short-term repo funding could be particularly volatile during periods of financial stress. Econometric analysis finds that about 25% of a reduction in repo funding to a given bank by one of its counterparties is replaced by other institutions on the same trading day (Chart B, panel b). However, reductions in repo funding from the NBFI sector could be challenging for banks to replace, potentially forcing them to shrink their balance sheets. For example, a reduction of €1 in repo funding from investment funds correlates with a further reduction of €0.26 in repo funding from other, similar institutions, after controlling for overall changes in banks’ demand for funding.

Chart B

Different NBFI sectors provide different types of bank funding, leading to limited substitutability in the event of lower funding supply

a) Market-based bank funding, by instrument and providing sector	b) Change of bank repo funding after €1 loss of repo funding provided by other banks or non-banks
(Q1 2021, Q4 2023; percentages)	(point estimates and 90% confidence bands, €)

Some recent episodes of liquidity turmoil in the NBFI sector led to financial stability issues for banks,^[4] suggesting that more widespread shocks could affect banks’ ability to secure funding. NBFI entities play a pivotal role as key sources of funding for banks. All in all, this funding has not experienced major systemic stress events over the last few years, despite market shocks and banking sector tensions. Nevertheless, a high concentration of NBFI funding in some banks, together with NBFI sectoral preferences for specific funding instruments, could make swift substitution difficult should funding outflows materialise. In a crisis, uninsured depositors, high-net-worth individuals and professional investors are most likely to run. This creates a vulnerability for banks, in particular as regards short-term repo funding, although the ability to reuse collateral with other counterparties could mitigate these vulnerabilities. Indeed, the turmoil in March 2023 showed that banks facing liquidity difficulties can be at risk of failure, even if they comply with regulatory ratios.