EBA Examines Asset Encumbrance in Banking Sector
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.
Related Links
Keywords: Europe, EU, Banking, Asset Encumbrance, Credit Risk, Collateral, Covered Bonds, Central Bank Liquidity, MREL, EBA
Previous Article
CPMI-IOSCO Assess Continuity Planning of Market InfrastructuresRelated Articles
SEC Finalizes Climate-Related Disclosures Rule
The U.S. Securities and Exchange Commission (SEC) has finalized the long-awaited rule that mandates climate-related disclosures for domestic and foreign publicly listed companies in the U.S.
US Regulators Release Stress Test Scenarios for Banks
The U.S. regulators recently released baseline and severely adverse scenarios, along with other details, for stress testing the banks in 2024. The relevant U.S. banking regulators are the Federal Reserve Bank (FED), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC).
Asian Governments Aim for Interoperability in AI Governance Frameworks
The regulatory landscape for artificial intelligence (AI), including the generative kind, is evolving rapidly, with governments and regulators aiming to address the challenges and opportunities presented by this transformative technology.
EBA Proposes Operational Risk Standards Under Final Basel III Package
The European Union (EU) has been working on the final elements of Basel III standards, with endorsement of the Banking Package and the publication of the European Banking Authority (EBA) roadmap on Basel III implementation in December 2023.
EFRAG Proposes XBRL Taxonomy and Standard for Listed SMEs Under ESRS
The European Financial Reporting Advisory Group (EFRAG), which plays a crucial role in shaping corporate reporting standards in European Union (EU), is seeking comments, until May 21, 2024, on the Exposure Draft ESRS for listed SMEs.
ECB to Expand Climate Change Work in 2024-2025
Banking regulators worldwide are increasingly focusing on addressing, monitoring, and supervising the institutions' exposure to climate and environmental risks.
BIS Bulletin Examines Cognitive Limits of Large Language Models
The use cases of generative AI in the banking sector are evolving fast, with many institutions adopting the technology to enhance customer service and operational efficiency.
ECB is Conducting First Cyber Risk Stress Test for Banks
As part of the increasing regulatory focus on operational resilience, cyber risk stress testing is also becoming a crucial aspect of ensuring bank resilience in the face of cyber threats.
EBA Continues Momentum Toward Strengthening Prudential Rules for Banks
A few years down the road from the last global financial crisis, regulators are still issuing rules and monitoring banks to ensure that they comply with the regulations.
EU and UK Agencies Issue Updates on Final Basel III Rules
The European Commission (EC) recently issued an update informing that the European Council and the Parliament have endorsed the Banking Package implementing the final elements of Basel III standards