Newsletter on bank exposures to non-bank financial intermediaries

• The non-bank financial intermediary (NBFI) sector continues to grow and has the potential to cause financial stability concerns, though its size and the associated risks vary amongst member jurisdictions.
• Recent episodes of distress highlighted vulnerabilities and deficiencies in some banks' risk management practices related to NBFIs. Supervisors consider exposures to highly leveraged counterparties via derivatives and securities financing to be the riskiest. Supervisors are observing similar deficiencies in some banks' management of commodity-related counterparties.
• Supervisors will continue to monitor exposures, focus on the proper application of existing standards and guidance, and assess the level of observable data to improve the visibility of interconnections between banks and NBFIs.

The NBFI sector continues to gain relevance and increasingly provides credit intermediation and funding services to the real economy. This results in both direct and indirect interconnections between banks and NBFIs through multiple channels. The Committee is concerned about the growth of these exposures, given the often opaque and quickly evolving nature of the attendant risks. Recent episodes of NBFI distress, including the collapse of Archegos Capital Management and events leading to stresses in government bond markets (eg liability-driven investment strategies), have highlighted vulnerabilities and deficiencies in banks' risk management practices.

The Committee recently conducted a risk horizon scanning exercise related to banks' NBFI activities and discussed supervisory and policy implications resulting from the recent distress of specific NBFIs. These discussions highlighted the following:

• While the types of NBFIs and the size of banks' exposures to NBFIs vary across jurisdictions, these exposures are growing in size and have the potential to cause further financial stability concerns.
• Banks engage with NBFIs across a wide range of transactions. Common NBFI counterparties for banks are investment and pension funds as well as insurance companies and broker-dealers. Banks' exposures to NBFIs include traditional credit facilities such as credit lines and fully collateralised short-term wholesale loans. Banks are also exposed to NBFI counterparties through more complex instruments in the areas of derivatives and securities financing, leveraged lending and prime brokerage, which may give rise to counterparty credit and liquidity risks with concentration, illiquidity and leverage as key considerations.
• Supervisors consider bank exposures to highly leveraged counterparties involving derivatives and securities financing transactions to be the riskiest. These types of exposures raise concerns about opaque concentration risks and potential sudden market stress, stemming from margin calls and fire sales of assets. In some instances, supervisors also note an increasing risk with regards to cryptoasset-related services provided by NBFIs.

• The collapse of Archegos Capital Management highlighted deficiencies in some banks' risk management practices. Those deficiencies include:

  • insufficient governance and risk management frameworks, including risk monitoring and stress testing in relation to the business strategy;

  • inadequate collection of information on clients' positions and exposures as part of due diligence, and limited efforts to understand and assess clients' investing strategies;

  • the absence of comprehensive limit frameworks;

  • weak margining practices, including the use of "static" margining and inadequately calibrated margining by some banks; and

  • possible regulatory arbitrage behaviour regarding the leverage ratio requirement.

• Supervisors have encouraged banks to improve their practices by reviewing and enforcing existing guidelines and standards. Supervisors have put an increased focus on banks' risk management practices, emphasising rigorous onboarding due diligence and ongoing monitoring, risk-sensitive margining and the importance of robust information disclosures from investment fund counterparties.
• Recent supervisory work revealed weaknesses in some banks' risk management practices related to commodities trading and highlighted broader counterparty credit risk measurement and management challenges. These weaknesses are often similar to those highlighted in the collapse of Archegos Capital Management, including  the aggregation of counterparty risk exposure to effectively assess the concentration and illiquidity of risk positions, with additional weaknesses unique to commodities in governance, onboarding, risk monitoring and margining.
• Existing supervisory infrastructure regarding NBFI-related risk is generally sufficient. The Committee is discussing, including through other international forums, how to close data gaps and improve the visibility of interconnections between banks and NBFIs.

The Committee strongly encourages the proper application of existing standards and guidelines, as well as the full and timely implementation of the Basel III standards. It is committed to continuing to exchange supervisory views on banks' exposures to NBFIs including on recent episodes highlighting leverage, concentration and liquidity concerns in the non-bank sector and related supervisory practices. In addition, the Committee continues to contribute to the Financial Stability Board's work on assessing and addressing the risk from NBFIs.