A report from the joint committee of the European Supervisory Authorities (ESAs) has reiterated the risk posed to defined benefit occupational pension funds from sustained low interest rates, as revealed by EIOPA’s stress test, and warned of the implications of the rise of non-bank lending.

The report, released yesterday, is on “risks and vulnerabilities in the EU financial system”.

The joint committee is chaired by Gabriel Bernardino, chairman of the European Insurance and Occupational Pensions Authority (EIOPA).

The European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA) are also represented on the committee.

The report grouped risks into three main areas: the low profitability of financial institutions in the low yield environment, increasing interconnectedness of bank and non-bank entities, and potential contagion from China and emerging markets.

“The financial service industry struggles to offer adequate level of profitability and increasingly turns to a search-for-yield behaviour,” said Bernardino.

“Therefore, it is crucial the supervisory community adopt a forward-looking perspective, challenging business model sustainability.”

The report notes that the low-interest-rate environment was putting pressure on the investment fund industry, insurers and banks.

If prolonged, it also poses “significant challenges” to the resilience of defined benefit occupational pension funds, it adds.

This, it says, is shown by the results of EIOPA’s stress test of pension funds, as announced in January.

It repeats EIOPA’s conclusion that the stress test show IORPs are generally more vulnerable to market stresses than increases in longevity, and reiterates the deficits revealed by the stress test: €78bn on a national balance sheet basis and €428bn using a “market-consistent approach”, when sponsor support and pension protection schemes are not taken into consideration.

The report also highlights the risks posed by the increasing role played by non-bank and non-insurance financial institutions (NBNIFIs) in financing the economy.

It flags a 65% growth of euro-area investment funds over the past five years and says the size of the financial system beyond banks and insurers is equivalent to 87% of the banking system in the euro-area.

“The development of the marked-based funding is […] raising concerns regarding the interconnectedness between investment funds, banks and insurance companies,” according to the ESAs’ report.

Asset managers, it says, are the group impacting on the performance of companies in the other two sectors.

This is a reversal of the situation before 2012, when banks’ performance was most influential.

“This evidence is consistent with the growing importance of the asset management sector in terms of interconnectivity,” the report says.

Referencing a graph showing interconnections among banks, insurers and asset managers, the report notes that the active role recently played by asset managers “calls for further investigation, also with regard to their potential systemic relevance”.

Only banks and insurers are designated systemically relevant under current regulations, but NBNIFIs, despite their valuable role, “also increase the potential for spill-over effects and add to complexity”, according to the report.

“In this context,” it says, “negotiations around the finalisation of criteria for the definition of systemically important NBNIFIs are pending at the international level.”

The ESAs called on regulators to continue to support market-based funding measures – for example, by developing regulation for non-bank loan origination models.

They should, however, pay close attention to “ancillary, intrinsic risks”, such as concentration risks, cross-border exposures and regulatory arbitrage.

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