The European Union’s non-bank financial institution market grew to a record size last year, according to data published by the European Systemic Risk Board earlier this month.
The total assets held by EU investment funds and other financial institutions (OFIs) now stand at over €50.7tr — meaning this part of the market exceeds the banking sector by more than 20%.
Banks, of course, are subject to reams of regulations, befitting their size and stature in the economy.
While all the capital buffers, bail-in debt and HQLA might cause headaches for bank treasury teams, they do make the European banking system a far stronger and safer ecosystem.
Non-bank financial firms, however, are not bound by such guardrails. In fact, it is partly thanks to their freedom from regulation that NBFs have gained ground on the banking market since 2008, according to Claudia Buch, chair of the European Central Bank’s supervisory board.
There are, of course, many risks and vulnerabilities floating around the NBF market — including excessive leverage, mismatched liquidity and interconnectedness, according to the ESRB.
Meanwhile, the Board highlighted that data gaps, poor quality data and limited legal scope for regulators to share information "hinder authorities’ ability to fulfil their financial stability mandates effectively”.
Large chunks of the data used in the ESRB’s report do not cover the whole EU, and thus cannot give a holistic picture of the market.
On top of this, “different reporting frequencies and time lags in data provision further complicate risk monitoring,” the ESRB added.
For the Board, the shortage and low quality of data make monitoring and risk assessment tricky. Improvements are needed — especially as the NBF sector grows and grows.
Of course, regulatory bodies are looking to tackle these deficiencies.
The Bank of England, for instance, included NBFs alongside banks in a system-wide exercise that subjected the UK financial system to a theoretical market shock in late 2024. According to the Old Lady, this was the first of its kind.
Unsurprisingly, the Bank of England found a massive shock would probably lead to mass losses for some segments of the market, including money market funds and open-ended funds.
Of course, one could argue the Bank should already have known this after Liz Truss, briefly UK prime minister, ran a market shock exercise of her own in late 2022.
Meanwhile, the EU is planning to run a system-wide stress test of its own in the coming year, which would measure the impact on NBFs.
Over the last five years alone, markets have been buffeted by wave after wave of shocks: the Covid pandemic, the collapse of Archegos Capital, the post-pandemic liquidity squeeze, Russia’s invasion of Ukraine, the 2023 US banking liquidity crisis, the fall of Credit Suisse, the potential for a crypto bubble, tariffs, France — the list stretches on.
Thankfully, none of these has brought down the NBF system — yet. But the threat still remains.
These firms are operating with minimal controls in an increasingly volatile world. As the NBF market grows, so does the need for stronger regulation.
Of course, regulation should not mean restriction. An effective regulatory regime for NBFs should encourage their growth, while nurturing their stability.
But regulating the smaller part of the financial system tightly and the larger part loosely no longer makes sense at all.