A study by the European Central Bank has looked at the potential spillover effects from the shadow banks towards the traditional banks in the Eurozone and warns that eurozone’s banks might be hit if the shadow banks run into trouble.
The shadow banks primarily consist of funds and other non-bank financial intermediaries (NBFI) that, in one form or another, receive loans from or provide loans to traditional banks.
The study found that exposure to the shadow banks, both in terms of loans and deposits, was concentrated in the top 13 euro zone’s traditional banks, including the eight globally important banks.
The main risk identified in the report is the potential withdrawal of funds by shadow banks, which represent around 13% of traditional banks’ total liabilities. Such a withdrawal of funds might happen if the shadow banks were to encounter withdrawal of funds themselves or if they lost confidence in the traditional banks where they have placed their funds.
According to the ECB, “This funding may be highly sensitive to the credit quality of the recipient banks and can amplify the funding pressures faced by banks if the soundness of their fundamentals has been called into question”.
Another potential spillover effect emphasized by the ECB is related to the potential forced sales of assets by the shadow banks. Given that the portfolios of traditional banks and shadow banks often share similar characteristics or are correlated, such a forced sale of assets would hit the asset prices and cause losses to the traditional banks.
The report also emphasizes the potential spillover effects from traditional banks towards the shadow banks, stating that “If one or a group of such (banks) were to become distressed, there would probably be substantial ramifications in terms of the ability of significant parts of the NBFI sector to manage liquidity and market risks”.
The ECB study does not name any of the banks included in the study but increases awareness of the inter-exposure between the traditional banks and shadow banks in the eurozone.