EBA guidelines limit European banks’ exposure to shadow banks

The European Banking Authority (EBA) has set out new guidelines limiting the exposure of financial firms in the European Union (EU) to the shadow banking sector. It also, on December 15, published a wide-ranging empirical survey of the firms' exposure to shadow banking entities, describing it as "the first of its kind" in the region.

Under the guidelines, firms will need to set limits "as part of their internal processes" on both their individual and aggregate exposures to shadow banking entities.

This will apply where the exposure is valued at or above 0.25% of the institution's eligible capital, after credit risk mitigation (CRM) and exemptions. The 0.25% materiality threshold "reduces the burden" of the guidelines' application, the EBA says, allowing firms to "disregard" exposures "not likely to pose risks that would deserve special attention".

Under the guidelines, firms should "set risk tolerance levels" for exposure to shadow banking "within their overall business model and risk management framework", and "under the supervision of the competent authority", the EBA says.

The competent authorities' assessment of this will be guided by the Supervisory Review and Evaluation Process (SREP), the EBA says. Where "appropriate", the EBA guidelines say, competent authorities will consider assigning Pillar 2 requirements "on specific institutions".

This approach will strike "the right balance" between "allowing institutions to set their risk appetite for exposures to shadow banking" and preventing "excessive risk to the financial system", the EBA says.

Principles and limits

Section 4 of the guidelines sets out the "general principles" firms should comply with. These include identifying their individual exposures to shadow banking, associated risks and their impact, and putting internal risk management procedures in place.

Each firm must set out its "risk tolerance/risk appetite for exposure to shadow banking entities". Firms must also have a "robust process for determining interconnectedness" both between different shadow banking entities, and between shadow banking entities and the firm itself.

Section 5 of the guidelines stipulates firms must "set an aggregate limit" to their shadow banking exposures "relative to their eligible capital". Firms must also set "tighter limits on their individual exposures to shadow banking entities", the EBA says, "independently of the aggregate limit".

Limits on exposures to individual shadow banking entities should be guided by multiple factors, the guidelines say, including the regulatory status and financial situation of the entity, and assessments of its risk and interconnectedness.

If firms "are not able to apply" the approach set out in Section 5, the EBA says, they must use what it calls the "fallback approach", implementing the "limits to large exposures" set out elsewhere in EU regulations.

As the next stage in the process, the EBA will translate the documents into all EU languages and publish them online, a process which an EBA spokeswoman says will take at least two months. Once all translated documents have been published, the competent regulatory authorities in each EU country will have a further two months to report to the EBA on whether they are complying with the guidelines. The guidelines themselves will apply from January 1, 2017.

Survey findings

The EBA also published a wide-ranging data collection exercise on EU firms' exposure to the shadow banking sector. It compiles data from 184 private sector financial institutions from 28 European countries, with data from seven countries bundled together. The sample size for each country varies widely. Measured by assets, 85% of the British, 55% of the German, 75% of the French and 61% of the Italian finance sectors participated.

"Group 1" banks – internationally active European banks with Tier 1 capital in excess of €3 billion – have the largest aggregate exposures to the shadow banking sector, followed by smaller "Group 2" banks. Investment firms are most exposed when considering the value of exposures to shadow banks as a percentage of their eligible capital.

If a limit of 25% of each institution's eligible capital was applied to its aggregate exposure to shadow banking entities, the EBA says, then 65 institutions, or approximately 47% of its sample, would be "in breach" of the restriction.

The survey classifies 89% of shadow banking counterparties as "other" with regard to supervisory regime, meaning either that they are "considered as non-supervised or have not been further identified by the institutions", the EBA says.