The European Banking Authority (EBA) published its annual report on asset encumbrance in banking sector. As COVID-19 spread across Europe, banks made extensive use of central bank facilities to strengthen their liquidity buffers and maintain the flow of credit to the real economy. The report highlights that this has resulted in the largest yearly rise in the asset encumbrance ratio so far. Amid wholesale funding tensions in the first half of 2020, banks made an extensive use of secured funding to maintain their support to the real economy. The substantial increase in total assets was outpaced by the rise in encumbered assets and collateral.
The following are the additional key findings presented in the report:
- Different banks’ business models might explain the differences in encumbrance. These differences are observed in the proportion of encumbered assets and collateral, the types of assets that are encumbered or the sources of encumbrance.
- Central bank funding has become the main source of asset encumbrance. The extensive use of central bank liquidity facilities has driven up the share of central bank funding over total sources of encumbrance. Thus, more than half of central bank eligible assets are already encumbered. In contrast, banks have reduced their reliance on covered bonds, given the favorable conditions of central bank facilities, an increasing deposit base, and focus on the issuance of Minimum Requirement for Own Funds and Eligible Liabilities (MREL) eligible instruments.
- After a sharp rise, the average overcollateralization level of banks’ secured funding returned to pre-COVID levels. Amid market tensions in the first quarter of 2020, banks were requested margin calls and had to pledge additional collateral to obtain secured funding. As market instability receded and ECB eased collateral requirements, overcollateralization levels returned to pre-pandemic levels. Nonetheless, this metric remains higher for certain funding categories such as derivatives.
- Increasing encumbrance ratios might pose prudential risks. Although banks exhibit comfortable liquidity buffers, as encumbrance subordinates unsecured creditors, the latter might demand higher spreads. Moreover, secured creditors may apply larger haircuts on collateral or make margin calls. This could lead to an adverse feedback loop of higher encumbrance and higher funding costs.
Keywords: Europe, EU, Banking, Asset Encumbrance, Credit Risk, Collateral, Covered Bonds, Central Bank Liquidity, MREL, EBA
Previous ArticleCPMI-IOSCO Assess Continuity Planning of Market Infrastructures
In a letter addressed to the industry, the Australian Prudential Regulation Authority (APRA) set out an updated schedule of policy priorities for the banking, insurance, and superannuation industries.
The European Commission (EC) adopted a comprehensive review package of Solvency II rules in the European Union.
The Office of the Comptroller of the Currency (OCC) issued Versions 1.0 of the "Earnings" and "Regulatory Reporting" booklets of the Comptroller's Handbook.
The European Central Bank (ECB) published results of its economy-wide climate stress test, which aimed to assess the resilience of non-financial corporates and euro area banks to climate risks.
The European Banking Authority (EBA) published a report on the use of digital platforms in the banking and payments sector in European Union.
The Hong Kong Monetary Authority (HKMA) published updates on the policy measures that were announced in context of the ongoing pandemic.
The International Swaps and Derivatives Association (ISDA), along with several other associations, submitted a joint response to the Basel Committee on Banking Supervision (BCBS) consultation on preliminary proposals for the prudential treatment of cryptoasset exposures.
BIS published the September issue of the Quarterly Review, which contains special features that analyze the rapid rise in equity funding for financial technology firms, the effectiveness of policy measures in response to pandemic, and the evolution of international banking.
The Basel Committee for Banking Supervision (BCBS) met in September 2021 and reviewed climate-related financial risks, discussed impact of digitalization, and welcomed efforts by the International Financial Reporting Standards (IFRS) Foundation to develop a common set of sustainability reporting standards
The Office of the Comptroller of the Currency (OCC) issued a Cease and Desist Order against MUFG Union Bank for deficiencies in technology and operational risk governance.