European regulators are planning a stress test to identify vulnerabilities beyond the traditional banking sector, focusing on less regulated entities such as hedge funds, private equity and credit managers, and other alternative asset players, according to a report by the Financial Times. The initiative aims to assess the potential impact of a market crisis on the broader financial system and could also include pension funds and insurance companies.
The first of its kind in the EU, the planned stress test aims to assess how a systemic market shock could ripple through entities such as hedge funds, private equity firms, pension funds, and insurers. While the framework is still being developed, regulators are hopeful it could be rolled out as early as 2026, according to the Financial Times. The initiative underscores growing concerns about the increasing role of non-bank lenders in the financial system. At the end of 2023, non-banks accounted for roughly a quarter of the €19 trillion in loans across the Eurozone, according to the European Central Bank, which noted that “more and more loans are being provided by insurance corporations and pension funds.”
“We’ve seen some crisis episodes…where liquidity risk spillovers came from the NBFI, non-bank financial intermediation space,” Claudia Buch, chair of the ECB’s supervisory board, told the European parliament during a recent hearing. “It’s important that this is also well understood and well regulated,” Buch added. “So not all NBFIs are more risky than banks or other financial institutions, but we need to address the risks there in the right way and also the regulation needs to be targeted to those risks.”
“So not all NBFIs are more risky than banks or other financial institutions, but we need to address the risks there in the right way and also the regulation needs to be targeted to those risks.”
Claudia Buch, Chair of the Single Supervisory Mechanism (SSM) of the European Central Bank (ECB).
The EU’s proposed stress test may represent a significant shift in how hedge funds and private credit groups are regulated, introducing the prospect of enhanced transparency requirements, leverage restrictions, or capital buffers. Unlike current stress tests that focus on individual sectors such as banking, insurance, or money market funds, this initiative aims to capture systemic vulnerabilities by examining how shocks could spread across the entire financial system.
The move comes as regulators across jurisdictions step up efforts to identify systemic vulnerabilities linked to the shadow banking sector. In the UK, the Bank of England used a “system-wide exploratory scenario” to simulate how stress at non-bank entities such as hedge funds could ripple through financial markets. The objective is to understand how a crisis might propagate through various parts of the financial system and whether these interlinkages could amplify, rather than absorb, the shock.
The Bank of England engaged more than 50 institutions in London in its so-called system-wide exploratory scenario, which included the hypothetical default of a hedge fund, to assess how stress could ripple through the non-bank financial sector. The central bank cautioned that forced asset sales by pension funds, hedge funds, and other investors could intensify a market crisis, particularly given widespread “mismatched expectations” about how easily they could raise liquidity in a downturn.
