The ECB asks banks to be selective with risk clients, including hedge funds

FILE PHOTO: The European Central Bank (ECB) building, in Frankfurt, Germany, July 21, 2022. REUTERS/Wolfgang Rattay
FILE PHOTO: The European Central Bank (ECB) building, in Frankfurt, Germany, July 21, 2022. REUTERS/Wolfgang Rattay

FRANKFURT, Jan 13 (Reuters) – Banks in the euro zone must be more selective with customers who make risky bets on financial markets, such as hedge funds, and be more prudent in managing their exposure to them, the European Central Bank said on Friday.

The ECB move shows how regulators are intensifying scrutiny of the role of non-banks, a sector that has grown to account for roughly half of the global financial system.

The so-called non-bank sector exploded in the aftermath of the global financial crisis as major banks became more strictly regulated, and its volume is estimated at about $240 trillion, according to the G20 Financial Stability Board.

The nonbank market has opaque “hidden leverage” pockets, where nonbanks—such as hedge funds or brokerage firms—borrow from banks to operate and access liquidity.

The ECB’s top supervisor, Andrea Enria, urged banks on Friday to be more demanding with this type of client and to say no when an operation is too risky.

“Failure to provide information from a client should lead to a more conservative approach to collateral, margin and limits, or even rejection or exclusion of clients,” Enria said in a blog post.

According to Enria, the ECB has found that the low interest rate environment has “incentivized some banks to increase the volume of capital market services provided to riskier and less transparent counterparties, including non-bank financial institutions such as hedge funds.” ‘ and ‘family offices’ (family wealth management instruments)”.

Following the bankruptcy of family office Archegos in 2021, which caused heavy losses for Credit Suisse and others, the ECB carried out a review of the way eurozone banks manage the risk of a customer breaching an derivatives.

The bank also examined links between banks and commodity traders and energy companies in the wake of volatility in those markets due to Russia’s war in Ukraine.

Enria said the ECB had found “some progress” but also “a number of material deficiencies”, ranging from the amount of collateral banks require from these clients to the legal terms of their contracts.

He said the ECB “will use the full spectrum of supervisory tools to ensure that supervised banks quickly fill gaps.”

The ECB can make so-called “qualitative” demands, such as that a bank tighten its controls, but also increase a bank’s capital and liquidity requirements if it believes its requests have not been taken into account.

Enria said the ECB’s review has also revealed that the legal terms of derivative contracts “seem to have been relaxed under commercial pressure” and that early warning indicators, such as collateral payment timeliness, have not always been taken into account. .

The ECB has asked banks to carry out internal “stress tests” for what is known as counterparty credit risk and “fire drills” of their ability to close a customer relationship when it has deteriorated.

(Reporting by Francesco Canepa and Huw Jones; editing in Spanish by Flora Gómez)

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