Europe’s top banking regulator has raised concerns about the rapidly growing market for banks’ significant risk transfers (SRTs), of which pension funds are buyers.
In its Spring Assessment Report, the European Banking Authority said that an increasing number of lenders on the continent are engaging in SRTs, which allow banks to insure loans against default by selling credit-linked notes to pension, sovereign wealth and hedge funds.
These transactions allow banks to free up capital that they would otherwise use to meet regulatory requirements.
“It remains important that this risk is also properly managed by banks going forward, not least amid their rising SRT usage: If these newly issued SRTs have similar maturities, it can quickly happen that a maturity wall is built up in the future," the EBA said.
The EBA stated that, so far, data for the wider banking sector does not indicate the existence of such a "maturity wall".
The regulator also warned about the potential “circles of risks" being created by banks providing funds to investors that are taking on credit risk from other lenders.
“It remains paramount to understand whether banks are, for instance, investing in private credit funds or other non-bank financial intermediaries that then invest in banks’ SRTs,” it said.
Private credit funds are the main investors in SRTs relative terms, with about a third of the market, followed by other investment funds, insurance companies and pension funds, showing the interlinkages in the financial sector, the EBA added.
Pension funds account for 13 per cent of the market, according to the report, but they could have indirect exposures to SRTs via other investments.
These tools have long been used by European banks, but they have become more prominent among global investors more recently after US banks entered the market.
More than half the banks in the region have issued SRTs, and roughly three-quarters of these banks plan to keep doing so in the future. In addition, around 20 per cent of the lenders that have never engaged in SRTs plan to do so, according to the EBA’s report.
The EBA’s warning comes after concerns were raised by other regulators around the world.
Last year, the International Monetary Fund called on banking supervisors to look into the rising use of this technique to remove risks from their balance sheets and transfer them to investors by leaving them on the hook in the case of borrowers’ default.
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