Non-bank financial institutions: understanding transmission channels and regulatory challenges

Contribution by Patrick Montagner, Member of the Supervisory Board of the ECB, for Eurofi Magazine

Copenhagen, 17 September 2025

In recent years, non-bank financial institutions (NBFIs) have become more prominent in financial intermediation, attracting greater attention from authorities worldwide. While NBFIs now account for more than half of financial sector assets in the euro area,^[1] their significance and market dynamics vary considerably across entity types and jurisdictions. NBFIs encompass a wide range of entities, with different business models, balance sheet structures and regulatory frameworks – a reality that requires tailored approaches to address systemic risk. At the same time, interlinkages with banks and the rest of the economy, as well as across borders, require a global and system-wide perspective on the risks arising from NBFIs. In a globally connected financial system, international cooperation is essential to ensure consistent outcomes in regulating non-bank financial intermediation and to safeguard financial stability.

Understanding NBFI risks and transmission channels

We first need to understand the various business models and identify potential transmission channels of financial distress. One such transmission channel potentially amplifying shocks is the NBFI sector’s link to the economy. Money market funds, for instance, offer short-term investment opportunities for small and medium-sized enterprises and larger corporates. During times of stress, sudden redemptions may trigger liquidity mismatches, with spillovers to the wider economy.

The interconnectedness with the banking sector is another critical transmission channel. Banks and NBFIs are linked through a complex web of relationships. Banks now serve as counterparties in foreign exchange and interest rate swap networks, provide prime brokerage services with margin financing and maintain direct exposures to NBFI-issued instruments. These connections create amplification mechanisms that could transform localised shocks into system-wide disruptions. Recent ECB analysis^[2], for example, revealed significant developments in private market funds, where assets under management have grown fivefold over the past decade. These entities can be part of more complex structures involving banks, through what we call “layered leverage” – borrowed capital introduced at multiple points along investment chains, from fund investors to portfolio companies themselves. When banks finance several levels of these chains simultaneously, seemingly straightforward exposures become intricate networks of related risks sharing common vulnerabilities.

Identifying new actors and the need for tailored regulation

The lines between asset managers, private equity firms, insurers and private credit funds are becoming increasingly blurred. For instance, private credit funds typically perform credit intermediation functions traditionally associated with banks, particularly in corporate credit markets, but without being subject to the same prudential requirements. Traditional classifications by product or entity type no longer fully capture the reality of more complex intermediation chains.

New regulatory and supervisory approaches are needed to address specific vulnerabilities. In a fast-evolving environment, microprudential banking supervision is sharpening its focus on banks’ risk concentrations and interlinkages with the NBFI sector. For instance, this year the ECB has conducted an exploratory scenario analysis on counterparty credit risk (CCR)^[3] to strengthen supervised entities’ ability to model CCR under diverse stress conditions and provide a better understanding of vulnerabilities stemming from interlinkages with NBFIs. The exercise revealed significant variation in banks’ CCR exposures, with differences in collateral practices having a considerable influence on stress profiles.

A broader macroprudential perspective is also needed to identify and address systemic risks in the NBFI sector. This should include assessing risks across financial sectors from a system-wide perspective, as well as enhancing the coordination of macroprudential policies for NBFIs at the EU level. The European Systemic Risk Board is well placed to support this effort. In addition, more integrated supervision of NBFIs would be a significant step towards developing EU capital markets.^[4]

To address the systemic risks posed by NBFIs, we must also enhance the macroprudential toolkit at the EU level and complement existing rules focusing on investor protection and market integrity.^[5] The Eurosystem made several recommendations in its response to the European Commission’s consultation on non-bank financial intermediation.^[6] First, Europe needs to swiftly implement recently agreed international reforms to the NBFI regulatory framework. This includes reforms to enhance the resilience of money market funds and to address vulnerabilities from liquidity mismatch in open-ended funds. Second, system-wide stress tests are essential to identify and quantify risks across the financial system. And third, effective oversight of NBFIs requires improved coordination between authorities and better access to data. Finally, in the context of increasingly complex and diversified NBFI structures, adopting an activity-based perspective, in addition to an entity-based perspective, is essential. It would allow regulators and supervisors to holistically assess and address risks wherever they arise, ensuring that the regulatory perimeter captures all relevant risks and remains adaptable to financial innovation.