The boundary between banking entities and the so-called non-banking financial entities or shadow banking system is increasingly blurred. Banking groups own insurance and investment fund businesses, while the asset management sector is increasingly powerful and increasingly takes on banking functions, such as granting credit. Both sectors, banking and non-banking, need financing to carry out their activities, in a growing interdependence through which funds and hedge funds They deposit their cash in banks while banks lend them money for their investments, in many cases with leverage.
The ECB warns that while these linkages are generally small, they make the banking system vulnerable to a financial shock. And he adds that in the event of liquidity problems, and given the need for both parties to reduce debt, “urgent sales with systemic consequences” could be triggered. According to the ECB, the risk of banks belonging to entities that base their business on leverage is estimated at approximately €432 billion. This is a quarter of the total financing granted to insurance companies, pension and investment funds hedge funds.
The ECB’s warning is not new. The recent past leaves strong financial turbulences such as the bankruptcy of family office The American Archegos, which left millionaire losses to banking giants of the time such as Credit Suisse or Nomura, or the failure of the American bank Silicon Valley, with a strong exposure to technology companies and the bond market and which infected a large part of the sector. In a preview of the financial stability report that the ECB will publish today, the central bank warns that “systemic risks may arise from links between banks and non-bank financial entities (insurers, funds, hedge funds) in two areas: vulnerability of liquidity in the banking system and granting of financial leverage to non-banking financial entities.
Therefore, the liquidity provided to banks by these players “may be difficult to replace in the short term” and in a volatile market environment may amplify risks, especially in banks operating with limited liquidity reserves. Specifically, five banks – all systemic – account for around 65% of total repo lending by shadow banking entities in the eurozone. On the other hand, insurers, funds and hedge funds They also finance banks through bonds: as of June 2025, shadow banks owned around a third of outstanding bank bonds, amounting to €1.5 trillion.
Lever
In parallel, the shadow banking system obtains funding from traditional banks to develop, an increasingly popular alternative in the money market. Banks’ exposure to shadow banking equates to around 10% of their total assets and is particularly high among banks in Germany, France, the Netherlands and Ireland, according to the ECB. Loans to financial intermediaries, such as brokers, securities firms or securitization vehicles, represent approximately 50% of euro area banks’ credit exposure to non-bank financial entities, followed by loans granted to investment funds, with 18%.
Providing credit to shadow banks carries additional risk, as many of these entities have leverage underlying their business. The ECB explains that, according to the latest available data, of the 1,660 billion euros identifiable as the total exposure of traditional banks to shadow banking, approximately 432 billion have to do with companies with a business model based on financial leverage, 26% of the total. “Non-bank entities operating in residential or commercial real estate (such as real estate investment trusts, REITs), as well as private credit or venture capital funds, hedge funds, international securities or commodities trading firms and loan providers (such as financial leasing companies), use leverage to achieve their investment objectives,” notes the ECB. In contrast, other non-bank financial institutions, such as insurance companies, pension and investment funds, are assumed not to use leverage or to a limited extent due to regulatory restrictions.
It is in these mutual flows of financing between banks and the shadow banking system that, according to the ECB, lies the vulnerability of the banking system. Therefore, disruptions in asset prices and redemptions can lead shadow banks to withdraw liquidity from Eurozone banks. At the same time, market fluctuations may also cause banks to reduce their funding, and leverage, in the shadow banking system, resulting in them being forced to liquidate positions. In short, an interconnection that the ECB now recognizes as “of limited extent” but from which it does not look away and on which it regrets not having sufficient data. “This in-depth analysis of the non-bank financial institutions sector is limited by data availability. Key data on the balance sheets of potentially leveraged entities, such as private equity funds, private credit funds and hedge funds outside the EU, as well as on the financing of deposits of non-bank financial institutions to banks are not available,” concludes the ECB.
