The ESRB: bank funding and the regulation of money market funds

Date 19/02/2013

Funding of credit institutions

Since the global financial crisis began in 2008, the banks have changed their sources of funding to a great extent. One of the clearest changes is that the banks have increased their dependence on secured funding, for example covered bonds. Another change is that the banks are using innovative funding to a greater extent, which makes it more difficult for investors and authorities to see where the risks are. The increased dependence on secured funding has led to a substantial increase in the proportion of encumbered, or pledged, assets at banks around the world. The ESRB believes that this could lead to risks to financial stability in that the resilience of the banks in periods of stress may be weakened if the assets are encumbered.

The ESRB recommends the national supervisory authorities in the EU to strengthen their oversight of secured funding. The banks should also improve their risk management tools that help mitigating risks from secured funding. The ESRB also recommends greater transparency about encumbered assets in the banks' public reporting. This recommendation thus has consequences for all major European banks, including the Swedish banks.

"The ESRB's recommendations are welcome. The banks' dependence on secured funding is an important issue. In the latest Financial Stability Report, we recommended the major Swedish banks to improve the transparency of their reporting about encumbered assets, and they have already begun to follow this recommendation. Transparency enables investors and other stakeholders to take better account of the risks associated with a bank's secured debt," says Stefan Ingves.

Regulation of money market funds

The ESRB's second recommendation aims to reduce the systemic risks arising from money market funds. The recommendation mainly applies to money market funds with a constant net asset value (CNAV). During the financial crisis, these funds were subject to bank runs. This led to major disruptions on the money market which in turn exacerbated the financial crisis. Several financial institutions that offered money market funds through their fund management companies were also forced to inject money to protect unit holders who had invested in these funds. This undermined the financial standing of these financial institutions.

To counteract the risk of such situations arising again, global standards for the regulation of money market funds have been drawn up. This has been done by the Financial Stability Board (FSB) together with the International Organization of Securities Commissions (IOSCO). The ESRB's recommendation calls on the European Commission to support the implementation of these standards within the EU. The ESRB recommends the prohibition of money market funds that offer CNAVs. The ESRB also recommends the introduction of stricter requirements for reporting and liquidity management in money market funds. At present there are no money market funds with a constant net asset value in Sweden. However, other parts of the recommendation will have consequences for the Swedish money market funds.

"Although the operations of money market funds are limited in Sweden, this recommendation is important to financial stability in Sweden as money market funds are an important source of funding for Swedish banks," says Stefan Ingves.