Systemic risks in linkages between banks and the non-bank financial sector

Prepared by Paul Bochmann, Daniel Dieckelmann, Maciej Grodzicki, Aoife Horan, Chloe Larkou and Francesca Lenoci^[1]

Linkages between euro area banks and entities in the non-bank financial intermediation (NBFI) sector may lead to the emergence of systemic risk in at least two fields. First, the banking sector receives short-term deposit, repo and debt securities liabilities from NBFI entities. Such liabilities may be prone to flight risk and difficult to substitute. Second, euro area banks provide credit to NBFI entities which follow leveraged investment strategies. Hedge funds, mainly based outside of the euro area, together with non-bank lenders and real estate funds are the main groups of such leveraged NBFI entities. These interconnections are particularly important for euro area global systemically important banks (G-SIBs), which play a central role in financial intermediation and transform short-term NBFI liabilities into credit granted to other NBFI entities. While the scale of these linkages is generally contained, they could make euro area banks vulnerable to asset price shocks which, by triggering NBFI funding outflows and counterparty credit losses on exposures to NBFI entities, could lead to deleveraging by banks, reduced provision of leverage by banks to NBFI entities and asset fire sales. G-SIBs’ loss-absorbing capacity is thus essential to ensure the smooth provision of financial services in times of stress.

1 Introduction

Interconnections between banks and NBFI entities reflect the wide range of financial services the two sectors provide to each other. NBFI entities are a diverse group of intermediaries that perform a range of economic functions.^[2] However, most of them rely on banks to manage liquidity, obtain leverage and access financial markets (in which banks act as market-makers). Some NBFI entities invest in banks’ capital and long-term debt funding and provide insurance and guarantees.^[3] These activities expose both sectors to credit, market, liquidity and operational risks, resulting in a complex landscape of connections which may give rise to systemic risk. Recent episodes of financial stress have demonstrated how the concentration of these connections among single firms^[4] or groups of similar firms^[5] could raise financial stability concerns.

Systemic risks may emerge from linkages between banks and NBFI entities in two areas: liquidity vulnerabilities in the banking system and the provision of leverage to NBFI entities. Previous work carried out by the ECB has established that euro area banks are net borrowers from the NBFI sector and that interactions in capital markets are a key channel through which stress can propagate between banks and NBFI entities.^[6] US research has shown that the expansion of the NBFI sector relies on banks as providers of leverage and contingent liquidity facilities to NBFI entities.^[7] These relationships have resulted in US banks becoming net creditors to the NBFI sector. Although the expansion of NBFI entities in the euro area has not been associated with tightening linkages between banks and NBFI entities to the same degree,^[8] euro area banks also provide liquidity and leverage to euro area and global NBFI entities.

Granular datasets shed light on how linkages between banks and NBFI entities differ by entity size, business model, geography, currency and maturity. This special feature combines multiple trade and exposure-level datasets to shed further light on key interlinkages between euro area banks and NBFI entities and highlight the associated systemic risks to financial stability. The analysis has limits, however, since it investigates neither ownership links nor the role of NBFI entities as credit insurers or protection providers. Future work may examine these aspects and take stock of existing work on ownership links.^[9] In the following sections, the risks arising from liabilities to NBFI entities are investigated first, followed by those risks emerging from banks’ provision of leverage to NBFI entities. Last, the risks arising from banks’ intermediation role in financial markets are discussed.

2 Redemption and rollover risks in bank liabilities to NBFI entities

Bank liabilities obtained from NBFI entities may be prone to flight risk, given their short maturity, with dependencies concentrated in specific bank business models. On average, euro area banks finance 15% of their assets through liabilities to NBFI entities (Chart 5, panel c in the Overview). Approximately 60% of these liabilities comprise very short-term instruments such as deposits and repos (Chart B.1, panel a).^[10] Overnight and foreign currency liabilities, which may be particularly prone to outflows during periods of market stress, constitute a large part of repo borrowing by euro area banks from NBFI entities (Chart B.1, panel b). However, as these liabilities result from intermediation activity, they tend to be matched by corresponding reverse repo lending in the same currency (Section 4 in this special feature). NBFI entities often place cash buffers with banks and may withdraw their deposits when facing redemptions or margin calls.^[11] In some cases, however, they may also increase their deposit holdings, either for a precautionary reason, or because of a changing risk appetite. The volatility of liabilities obtained from NBFI entities is higher in bank business models with a larger share of such liabilities, especially in the case of deposits and repos from NBFI entities as opposed to deposits from other counterparties such as non-financial corporations, households and banks (Chart B.1, panel c).

Chart B.1

Banks’ liabilities to NBFI entities are short-term and may be volatile

a) Euro area banks’ deposits and repo liabilities to NBFI entities, by bank business model	b) Euro area banks’ repo liabilities to NBFI entities, by currency and maturity	c) Volatility of short-term funding from NBFI entities and other counterparties, by bank business model
(Q2 2025; € trillions, percentages)	(Q3 2025, share of euro area banks’ total repo liabilities to NBFI entities)	(Q1 2016-Q2 2025, percentages)

Banks’ short-term liabilities from NBFI entities are concentrated and highly segmented at the level of individual banks. In particular, a small number of euro area banks hold a large share of total non-bank repo and deposit liabilities from NBFI entities. This is particularly evident in the repo market, where the top five banks – all G-SIBs – account for approximately 65% of euro area banks’ repo borrowing from NBFI entities (Chart B.2, panel a) while accounting for 35% of the total assets of euro area significant institutions. Short-term liabilities to NBFI entities are provided mainly by investment funds and other financial institutions (such as broker-dealers), while money market mutual funds lend US dollars on a secured basis and provide unsecured commercial paper funding. This segmentation reflects differences in the sizes of the NBFI sectors and their respective investment mandates. It also highlights the concern that funding outflows may be difficult to replace in the short term. This is because providers of specific types of liabilities tend to follow similar business models, which may result in concentrated withdrawals.^[12]

Chart B.2

Banks with highly specialised business models rely heavily on volatile liabilities to NBFI entities but maintain low liquidity buffers

a) Concentration of euro area banks’ deposit and repo liabilities from NBFI entities	b) Shares of liquid assets and liabilities from NBFI entities, for euro area significant institutions
(left graph: Q2 2025, right graph: Q3 2025; € billions)	(Q2 2025, percentages)

Relying on volatile and concentrated short-term funding can amplify risks, especially for banks operating with limited liquidity reserves. At the banking-system level, the flows in bank deposits from NBFI entities do not appear to be related to market volatility.^[13] This may indicate that NBFI entities need to place liquidity with banks for structural reasons. However, idiosyncratic shocks to an individual bank could prompt NBFI counterparties to reallocate funds to other banks. Some banks with a high share of liabilities to NBFI entities also tend to hold lower liquidity buffers than their peers, despite the potential risk of outflows (Chart B.2, panel b).^[14] In the event of funding stress triggered by NBFI outflows, such banks may need to rapidly sell assets or cut back on their provision of services to NBFI entities.

Some other NBFI entities provide stable long-term bond funding to euro area banks. As of June 2025, euro area NBFI entities held approximately one-third of outstanding euro area bank bonds, amounting to around €1.5 trillion. Insurance corporations and pension funds are a prominent class of investor in bank bonds, as they need to take duration risk to reduce their asset-liability mismatches. With long maturities spaced out over time, the liquidity risk associated with such funding is limited. However, a protracted loss of access to bond funding may also make it difficult for banks to comply with regulatory requirements such as the minimum requirement for own funds and eligible liabilities.

3 Credit risk arising from interconnections between banks and NBFI entities

Banks provide credit to a diverse group of NBFI entities, often on a collateralised basis. Euro area banks’ asset-side exposures to NBFI entities constitute about 10% of their total assets. Lending (including loans and reverse repos) and securities holdings constitute the most significant portion of banks’ on-balance-sheet exposures to NBFI entities, while derivatives also account for a notable share.^[15] Total bank credit exposures to NBFI entities as a share of total assets are highest in Germany, France and the Netherlands, as well as in Ireland, which is home to several subsidiaries of non-EU investment banks (Chart B.3, panel b). The high share of collateralised and short-maturity lending, such as that provided via reverse repos, reduces the credit risk banks are exposed to in their lending to NBFI entities (Chart B.3, panel a),^[16] although these exposures incur counterparty credit risk charges.^[17] Lending to other financial intermediaries, such as prime brokers, securities firms, securitisation vehicles, leasing units and financing conduits, represents about 50% of euro area significant institutions’ credit exposure to NBFI entities, followed by investment funds at 18% and captive financial institutions at 14.5% (Chart B.3, panel b).

Intragroup linkages, in which banks fund entities within the same financial group, are very common. Exposures to other financial intermediaries (OFIs) and captive financial institutions are often contained within the same banking group. At least 55% of credit exposures to OFIs are classified as intragroup.^[18] These exposures cannot be seen in consolidated banking data, but account for a large share of bilateral exposures visible in loan-level and security-level data. Such intragroup linkages are essential in financial conglomerates. Banks often provide a customer with multiple services which may be delivered by a dedicated NBFI entity. If the NBFI entity faces financial difficulties, the bank may opt to support it and absorb financial risks, even if it does not have a contractual obligation to do so, to mitigate legal and reputational risks.^[19]

Chart B.3

In aggregate, banks’ asset-side exposures are dominated by collateralised exposures, often contained within the banking group’s perimeter

a) Bank credit exposures to NBFI entities, by instrument type	b) Banks’ credit exposures to NBFI entities, by entity type
(Q4 2024, € billions)	(Q4 2024; € billions, percentage share of total bank assets in each country)

Lending to NBFI entities creates pockets of vulnerability, as many NBFI counterparties follow business models that are predicated on the use of leverage. A classification of NBFI entities by sector, business model and geographical location can shed light on the scale of bank interconnections with NBFI entities that are using leveraged strategies. NBFI entities that deal in residential or commercial real estate (such as real estate investment trusts, REITs), as well as private credit or private equity funds, hedge funds, international securities or commodities trading firms and loan originators (such as leasing companies), rely on leverage to achieve their investment objectives. However, the scale of such leverage and the resulting maturity and liquidity mismatches differ across firms and business models.^[20] This financial leverage is, to some extent, provided by euro area banks. The latest available data suggest that around €432 billion, or 26%, of the €1.66 trillion that can be identified of euro area banks’ total exposures to NBFI entities, involve such leveraged firms.^[21] Other NBFI entities, including insurance corporations, pension funds, money market and investment funds, financial auxiliaries and captive financial institutions, are assumed to use no or limited leverage, given that they are often tightly restricted by regulation.^[22]

Credit exposures to potentially leveraged NBFI entities are concentrated in G-SIBs, mainly via repo lending to hedge funds and risky trading and securities trading firms. G-SIBs maintain sizeable links to hedge funds and risky trading and securities firms (Chart B.4, panel a).^[23] Universal banks and diversified lenders are more diversified than G-SIBs, with a notable concentration in hedge funds and substantial exposures to real estate funds and non-bank lenders. Investment banks are more exposed to risky trading and securities firms, which is consistent with their business models. By contrast, less complex banks engage with these entities to a much smaller extent.

Hedge funds and risky trading and securities firms, which are typically more opaque, highly leveraged and prone to liquidity mismatches, account for the largest share of borrowing by leveraged NBFI entities from banks. Linkages with hedge funds and risky trading and securities firms are almost exclusively via the repo market, where banks provide very short-term collateralised loans. Other leveraged NBFI entities tend to use a more diverse mix of bank lending instruments, including revolving facilities and credit lines (Chart B.4, panel b).

The distribution of exposures to potentially leveraged NBFI entities relative to banks’ capital further highlights the heterogeneity that exists across business models (Chart B.4, panel c). While the median bank’s exposure is moderate for most business models, some banks, particularly G-SIBs and investment banks, show higher exposures relative to capital, reflecting their central role in providing leverage and liquidity to NBFI entities. By contrast, universal banks and retail lenders show more contained and less dispersed exposures, which is consistent with their more traditional intermediation role.

Chart B.4

Euro area bank exposures to leveraged NBFI entities are substantial and are highly dependent on business model

a) Banks’ exposures to leveraged NBFI entities, by bank business model and entity type	b) Share of instrument types in bank exposures, by NBFI entity type	c) Exposures to leveraged NBFI entities relative to capital, by bank business model
(Q4 2024; € billions, percentage shares)	(Q4 2024, percentages)	(Q4 2024, percentages of total capital)

Euro area banks’ holdings of debt securities issued by NBFI entities are dominated by long-dated securitisation bonds with low credit risk, a sizeable share of which are in US dollars. Banks’ holdings of debt securities issued by NBFI entities stand at slightly above €650 billion, or about 2.5% of total assets in aggregate. They do, however, differ across bank business models and individual banks. Similar to bank lending to NBFI entities, intragroup holdings are sizeable (Chart B.5, panel a).^[24] Asset managers and custodian banks are the largest holders of debt securities issued by NBFI entities, relative to total assets, albeit with pockets of high concentration which probably arise because they manage or hold investment portfolios.^[25] Euro area banks’ holdings of NBFI entities’ debt securities are dominated by securitisation bonds, whether purchased on the open market or retained (Chart B.5, panel b).^[26] Additionally, about 30% of bank holdings of such securities are denominated in US dollars. They consist mainly of long-dated agency mortgage-backed securities and offer a US dollar-denominated high-quality liquid asset reserve that provides a natural FX hedge against US dollar-denominated liabilities.^[27] Credit risk associated with banks’ holdings of securities issued by NBFI entities seems contained. However, their long maturity exposes banks to interest rate and liquidity risk (Chart B.5, panel c).

Chart B.5

Banks’ holdings of debt securities issued by NBFI entities

a) Holdings of debt securities issued by NBFI entities, by type and country	b) Holdings of debt securities issued by NBFI entities, by bond type and country	c) Residual maturity of securities holdings issued by NBFI entities, by bank business model
(Q2 2025; € billions, percentages)	(Q2 2025, percentages)	(Q2 2025, years)

Overall, euro area banks’ credit exposures to NBFI entities appear to carry generally low direct credit risk, owing to short maturities and collateralisation, but give rise to counterparty risk and step-in risk. A significant share of exposures is to leveraged NBFIs, and some G-SIBs and investment banks are significantly more exposed than aggregate figures suggest, creating potential tail risks. Furthermore, the concentration of funding provision to leveraged NBFIs in a few G-SIBs raises substitutability concerns, as market disruptions could be amplified during periods of stress should these banks withdraw. In addition, banks’ sizeable holdings of long-duration NBFI securities expose them to interest rate risk and liquidity risk.

4 Risks from banks’ role as intermediaries in financial markets

Banks and leveraged NBFI entities interact primarily in repo and derivatives markets. In this context, banks engage in various capital market activities with NBFI entities, primarily to meet client needs and to generate revenue through fees and intermediation spreads. G-SIBs and specialised institutions such as investment banks play a key role in making markets for debt and equity.

Chart B.6

There has been a rapid increase in interconnections between banks and NBFI entities via the repo market, driven by prime brokerage activities concentrated among systemic banks

a) Banks’ reverse repo lending, by recipient NBFI entity type	b) Concentration of NBFI entities’ repo borrowing from banks
(Jan. 2021-Sep. 2025, € billions)	(Sep. 2025; left graph: by bank, right graph: by borrower; € billions, number of links)

Euro area G-SIBs and investment banks intermediate between different groups of NBFI entities in the repo market, without taking large net positions. Repo intermediation activity has more than doubled since 2021, driven by increased lending to non-euro area investment funds (Chart B.6, panel a). This group, as presented in the previous section, consists mainly of hedge funds, which borrow US dollars from euro area G-SIBs.^[28] Repo intermediation is highly concentrated, with five banks making up around 80% of banks’ total reverse repo claims on NBFI entities (Chart B.6, panel b). These are the same banks that account for the large majority of repo borrowing from NBFI entities (Chart B.2, panel a). These banks typically maintain balanced books with other financial institutions and investment funds for both US dollar and euro-denominated secured financing (Chart B.7, panel a). Their net exposure in the repo market is limited and it appears they do not use net repo liabilities to fund other banking activities.

Chart B.7

In aggregate, banks keep balanced books in secured financing with NBFI entities and run matched derivatives books for major foreign currencies

a) Total amount of euro area banks’ US dollar and euro-denominated reverse repo lending and borrowing, by NBFI sector	b) Net notional positions of euro area banks with NBFI sectors in cross-currency interest rate swaps and FX derivatives, by currency
(July 2025, € billions)	(July 2025, € trillions)

In derivatives markets, large euro area banks play a central role as market-makers and clearing counterparties for NBFI entities. These activities facilitate investment and risk management by NBFI entities. Banks’ directional derivatives positions are typically limited, although there are exceptions for various contracts, such as interest rate derivatives used to hedge duration risk in banks’ own banking books. For major foreign currencies, banks also serve as key providers of liquidity and hedging instruments to NBFI entities through cross-currency interest rate swaps and FX derivatives (Chart B.7, panel b).

Even though their net positions with NBFI entities in the repo and derivatives markets are matched, banks are exposed to potentially systemic counterparty risk and liquidity risk. Banks trade repos and reverse repos with counterparties using a wide range of different business models. By and large, banks obtain cash in the repo market from money market mutual funds and broker-dealers and lend it to hedge funds and insurers. They also provide synthetic leverage to NBFI counterparties via derivatives. These trades are collateralised and are usually subject to margining, mitigating credit risk. Because of the mismatch between counterparties, however, repo and derivative activities entail liquidity risk and counterparty risk. In times of stress, banks may face a difficult trade-off between reducing their provision of financial services to clients and accepting higher levels of risk. Banks’ responses likely depend on their balance sheet capacity, including CET1 capital, leverage ratios and liquidity buffers.^[29]

5 Conclusions

This special feature highlights two important and interlinked systemic vulnerabilities emerging from euro area banks’ linkages with the NBFI sector. First, asset price shocks and redemption flows may prompt NBFI entities to withdraw liquidity from euro area banks, especially when liabilities to NBFI entities are concentrated, correlated and volatile. While some of the liabilities to NBFI entities are matched by short-term claims on NBFI entities, this nonetheless exposes banks to counterparty risk and rollover risk, as banks intermediate between different groups of NBFI counterparties. Second, market gyrations may prompt banks to procyclically reduce their provision of leverage to NBFI entities, forcing them to liquidate leveraged positions. This deleveraging, if complemented by a lack of market liquidity, could in turn depress asset prices further, potentially triggering fire sales with systemic consequences. Additionally, these two mechanisms could reinforce each other and could, potentially, have a common trigger. Mitigation strategies commonly deployed by banks include using collateral to reduce credit risk and maturity matching to reduce liquidity risk.

Euro area banks’ interconnections with potentially leveraged NBFI entities appear to be of limited magnitude. About a quarter of banks’ total credit exposures are to potentially leveraged NBFI entities.^[30] These exposures reflect the provision of leverage by euro area banks to hedge funds in the repo market and to real estate funds via long-term secured debt. As in the United States, interconnections with NBFI entities in the euro area include sizeable intragroup linkages.

Banks’ exposures to NBFI entities are highly concentrated on both sides of their balance sheets. While the magnitude of systemic risks to financial stability from idiosyncratic shocks to individual NBFI entities seems to be contained, distributions of asset- and liability-side exposures are heavily concentrated, from both a bank and an NBFI perspective. On the bank side, the small group of euro area G-SIBs plays a critical role and is difficult to replace. The loss-absorbing capacity of these G-SIBs is essential to maintain the smooth provision of financial services in times of stress.

Despite establishing important new facts, this in-depth analysis of the NBFI sector is constrained by data availability. Key data are not available for the balance sheets of potentially leveraged NBFI entities such as private equity, private credit and hedge funds outside the EU,^[31] as well as for deposit funding from NBFI entities to banks. Other granular data are geographically constrained, as transactions taking place outside the euro area are not reported to the euro area authorities in a granular format. These data gaps make it more difficult to comprehensively analyse the risks associated with linkages between banks and NBFI entities. Further work on complementing the AnaCredit dataset with data collected under the Alternative Investment Fund Managers Directive^[32] could provide further insights by extending the level of analysis on the amount and type of loan financing used by leveraged funds, the collateral they provide to lenders, and lender and borrower concentrations.