The fastest growing liability segments in EU and European Economic Area (EEA) banks’ funding plans are repos, long-term unsecured debt securities and client deposits. EU/EEA banks’ yearly issuance volumes are expected to rise significantly over the next three years, wrote the European Banking Authority (EBA) in a recent report.
Banks also plan to increase secured debt issuances sharply this year after comparatively low volumes in 2024. However, rather optimistic plans for this year might face challenges amid elevated market volatility that could be seen during parts of the first half of the year, and which might also similarly happen during the remainder of the year.
The increasing complexity and systemic nature of operational risks in the banking sector, driven by digitalization, technological advances, and heightened geopolitical tensions, have put these risks even further to the forefront.
Digitalization and technological advances, with related cyber risk, are a key driver of operational risk besides fraud, reputational challenges and the risk of financial crime, including anti-money laundering (AML) risk, and further conduct-related and legal risk.
“RWAs of operational risk have grown, reflecting its significance in the overall risk profile of banks,” the EBA wrote.
From abundant to ample reserves
To ensure a smooth transition to a state where central bank reserves are permanently lower, and to avoid volatility spikes in the overnight interest rates as banks’ activities in the money market increase, it is important for the banks, central banks and supervisors to anticipate when the aggregate liquidity conditions are likely to switch from “abundant” to “ample”.
There are signs that EU banks are already making such preparations, as seen in increased sovereign bond holdings and greater activity in the term repo markets beyond 30 days’ maturity. In the EA, a recent rise in volumes of term repo operations with maturities beyond 30 days suggests that banks may be seeking to improve their LCR ratios by exchanging Level 2 or non-HQLA assets for Level 1 assets in transactions that do not affect outflow rates.
“As EU banks will need to pay more attention to their liquidity requirements and liquidity management in the future, they may face new types of trade-offs between liquidity requirements and existing capital and resolution constraints,” the EBA wrote.
SRTs and repo
In addition, the report highlighted the use of significant risk transfers, also known as synthetic risk transfer (SRTs), which are increasingly used as a capital management instrument among EU/EEA banks helping them to release capital and increase their lending capacity. More banks aim to make use of them going forward.
EU/EEA banks’ SRTs are slightly more than half of their total securitization of around €1 trillion (here and in the following, considering securitized exposure as volume). Responses to a questionnaire similarly confirm the wide usage of SRTs by banks: more than half of the banks have so far made use of SRTs and around three-quarters of them aim to continue doing so going forward.
Around 20% of SRT users are not yet sure about future usage, whereas approximately 5% no longer want to make use of SRTs. Around 20% of banks that have never made use of an SRT aim to issue one in the future. Compared to other jurisdictions, EU/EEA banks have a comparatively big share in worldwide SRT markets, with some analysis estimating their share at around 50%. At EU/EEA banks, SRT exposure volume corresponds to around 2% of total credit exposure amounts (excluding retention). Nearly three quarters of SRTs’ underlying exposures are related to corporates, including small and medium sized enterprises and commercial real estate financing.
It remains paramount to understand whether banks are, for instance, investing in private credit funds or other non bank financial institutions (NBFIs) that then invest in banks’ SRTs. Such investments of banks could for instance be through lending to private credit funds or NBFIs, potentially contributing to these funds’ / NBFIs’ leverage. This could create certain “circles of risks”, as in the end a private credit fund’s SRT investment would become an implicit risk for a bank that invests – e.g. through providing repo-based or other funding – in that fund.