"EU Prepares First-Ever Stress Test Targeting Hedge Funds and Others"

Citing EU Regulatory Officials, FT Reports
Non-bank Sector Accounts for 25% of Eurozone Lending
Benefit from Relatively Looser Regulations

Christine Lagarde, President of the European Central Bank (ECB). Photo by Reuters-Yonhap News

The Financial Times (FT) reported on May 26 (local time) that European Union (EU) regulators are preparing the first-ever stress test to assess vulnerabilities in the financial system posed by non-bank financial institutions.

Multiple officials from major EU financial supervisory bodies told the FT that discussions are underway regarding stress tests targeting these institutions. The tests could be implemented as early as next year, with hedge funds, private credit firms, and money market funds (MMFs) expected to be included.

Since the onset of the 2008 global financial crisis, non-bank financial institutions have grown into major players in the lending market. This growth has been facilitated by comparatively looser regulations than those imposed on traditional banks.

According to the European Central Bank (ECB), as of the end of 2023, non-bank entities accounted for around 25% of total lending in the eurozone, which amounts to approximately 19 trillion euros. The ECB stated, "Insurance companies and pension funds are increasingly providing more loans."

Meanwhile, non-bank financial institutions have been repeatedly exposed to various financial market crises in recent years. These include the liquidity crisis in the bond market following the COVID-19 pandemic, the collapse of Archegos Capital, and the liquidity crisis in the energy trader market that emerged after Russia's invasion of Ukraine.

Claudia Buch, Chair of the ECB Supervisory Board, stated at a recent European Parliament hearing, "We have observed instances where liquidity risks have been transmitted from the non-bank financial intermediation (NBFI) sector during certain crisis situations." She emphasized, "Not all NBFIs are riskier than banks, but it is essential to properly identify the associated risks and apply appropriate regulations."

The FT also pointed out that the pace of strengthening regulations for money market funds (MMFs) in the EU has been slower than in the United States and the United Kingdom, which remains a source of concern. Some European countries, including France, are already preparing to introduce similar stress tests for non-bank financial intermediaries.

It is known that the discussions involve the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA), the European Insurance and Occupational Pensions Authority (EIOPA), the ECB, the European Commission, and the European Systemic Risk Board (ESRB). However, these agencies and the Commission did not comment to the FT.