Ireland is home to the world's fifth-largest "shadow banking" industry, with some €3.45 trillion of assets as of the end of 2020, mainly in IFSC-based international funds that invest in debt, according to the Central Bank.
The figure is based on a narrow definition of non-bank financial intermediaries (NBFI) activity used by the Basel-based Financial Stability Board (FSB). It has been leading a global effort in the past decade to search for potential risks in the increasingly complex area of international finance taking place outside banks.
While the FSB has stopped using the phrase "shadow banking" in recent years, it continues to be widely used to describe non-bank financial activities. The US has the world's largest NBFI sector, followed by China, the Cayman Islands and Luxembourg.
The Irish shadow banking sector has tripled in size in the past decade and now equates to nine times the size of the economy, driven by growth in investment and money market funds that put money into debt securities or have significant borrowings, the Central Bank said in a note published on Thursday. There were €2.09 trillion of assets in such investment funds at the end of 2020 and a further €630 billion in money market funds.
“Such funds could be subject to ‘bank-run’ like events, in the event of a shock,” according to the Central Bank note. “If many investors simultaneously withdraw money from a fund, the fund may need to firesale assets and impact broader market conditions, which can in turn spur further withdrawals and so on.”
Irish-based money market funds suffered investor withdrawals of 10 per cent in March 2020 as companies and banks rushed to grab cash at the height of the Covid-19 global financial shock, the Central Bank previously reported. All the funds were able to meet investor demands.
Most of the rest of the Irish NBFI sector, under FSB definitions, comprises special purpose vehicles used to house pools of international loans that are refinanced in the bond markets through a process called securitisation.
Banks often resort to securitisation to move loan portfolios off their balance sheet, which can help lower the cost of loans for their customers.
Irish banks have used securitisation to shift problem loans in recent years. While the Central Bank said this type of activity can allow banks to lend more money, it warned that it can lead to excessively high level of debt for an economy.
“They can also pose financial stability risks if the securitisation is funded with short maturities, and may be difficult to renew in periods of market stress such as experienced in 2007-2009,” the Central Bank note added. There were €443 million of assets in securitisation vehicles at the end of 2020.
In addition, there were €237 billion of assets in non-securitisation special purpose vehicles, it said.
Still, the NBFI measure under the FSB framework excludes a substantial portion of the Republic’s non-bank financial sector – including equity funds, insurance activities, pension funds and other financial intermediaries that do not have funding structures that pose risks to financial stability.
Adding these in would bring assets in Ireland’s shadow banking sector up to €5.75 billion.
The Central Bank's governor, Gabriel Makhlouf, signalled on taking up the role in late 2019 that he would place a major focus on risks attached to the shadow banking industry in the State, even though it has limited links to the domestic economy.