ECB’s Schnabel: Non-Bank Finance Needs Stronger Regulatory Framework

19 November 2020

By David Barwick – FRANKFURT (EconoStream) – The financial sector is in need of regulation that would make it stronger and lessen the risk of financial stability concerns dominating monetary policy, European Central Bank Executive Board member Isabel Schnabel said Thursday.

In a speech at a conference organised by the Federal Reserve Bank of Cleveland and the Office of Financial Research, Schnabel, according to a text provided by the ECB, welcomed the trend towards non-bank finance, but said that the liquidity crisis of such institutions in the immediate wake of the pandemic was due to ‘prevailing structural fault lines’.

These structural challenges included a lack of access to central bank balance sheets, an under-developed policy sectoral policy framework and in particular insufficient macroprudential regulation, she said.

When the pandemic erupted, systemic stress in the sector had to be relieved by ‘[f]orceful monetary policy action’, she said. However, monetary policy had to overcome the impaired intermediation of liquidity from banks to non-banks, she said.

Since the ECB could not overnight become lender of last resort for non-banks by permitting such institutions to become monetary policy counterparties, it chose to rely on the pandemic emergency purchase programme (PEPP), the announcement of which ‘instantly addressed the issue of illiquidity, instilled confidence and thereby reduced systemic stress and bond spreads’, she said.

‘But the success of central bank interventions should not distract from the fact that the underlying vulnerabilities in the non-bank sector need a structural fix, not least to mitigate the risk of moral hazard’, she said, but also to counter the risk of financial dominance.

‘Ensuring that central banks can pursue their mandates without risking financial stability requires a rethink of our current prudential framework’, she said. ‘It must be strengthened from a systemic risk perspective to ensure that it can be an effective first line of defence.’

Schnabel urged redressing the risks of mismatch between funds’ asset liquidity and their redemption policies, shoring up regulatory shortcomings regarding the use of leverage, and reforming the regulatory framework applied to money market funds so as to ‘mitigate liquidity mismatches and reduce the risk of suspensions during periods of stress.’