New research on Shadow Banking and Special Purpose Entities published

• Suite of research published on shadow banking sector in Ireland and role of Special Purpose Entities (SPE).
• Research aims to shed light on industry as part of a wider initiative to increase transparency in the area.
• While Irish-resident SPEs are not regulated by the Central Bank, more extensive statistical reporting requirements are imposed on SPEs in Ireland than other jurisdictions, to facilitate better insights on the sector.

The Central Bank of Ireland has today published a suite of research on the shadow banking sector in Ireland and the role of Special Purpose Entities (SPE).

An Economic Letter by Brian Golden and Patrick Hughes – Shining a Light on Special Purpose Entities in Ireland – provides a broad overview of the sector, with detail on interconnectedness to other financial entities, common business models, taxation and an assessment of the impact on the Irish economy.

The key findings are:

• Sponsoring entities behind SPEs are diverse, covering over 60 combinations of country and sector. For securitisation SPEs, sponsors tend to be EU and US banks and other financial institutions. Within non-securitisation SPEs (those not involved in securitisation and where credit risk does not pass to purchasers of loans or debt securities issued by the SPE) non-financial corporations (NFCs) are also prominent. Irish sponsors of securitisation SPEs are generally domestically-focused banks issuing debt on residential mortgages and, within non-securitisation SPEs, multi-national NFCs and Irish-resident funds.
• Business models illustrate how SPEs can be used by sponsors to pass on risk to investors, share returns on assets with investors, provide reassurances to obtain funding, drive tax efficiencies and originate loans.
• In 2017, the SPE industry paid €273 million in fees and commissions to Irish entities. Meanwhile, employment levels are very low given SPEs often have little or no physical presence. Within the balance of payments, the net impact is also limited as flows to and from SPEs are mostly between foreign entities.

A second Economic Letter by Brian Golden and Eduardo Maqui – Shadow banking risks in non-securitisation SPEs – outlines some of the potential risks within Irish-resident non-securitisation SPEs. These are SPEs not involved in securitisation and where credit risk does not pass to purchasers of loans or debt securities issued by the SPE.

The key findings are:

• Irish-resident non-securitisation SPE assets amounted to €331 billion at end 2017. €185 billion of this potentially formed part of shadow banking credit intermediation chains, i.e. acting as a conduit for credit intermediation by shadow banks.
• Shadow banking risks include leverage (lending activity or purchasing assets on credit), maturity/liquidity mismatches and interconnectedness. Shadow banking risks appear to be relatively contained, though more prominent for entities engaged in loan origination, bank-linked investment or external financing activity. The complexity of international connections and information gaps therein are a more general cause for concern.
• Non-securitisation SPEs, sponsored by entities from around 40 countries, are involved in complex cross-border structures which can intensify interconnectedness risks. While shadow banking risks appear to be concentrated in certain SPE activity types, this complexity could become a source of generalised instability in terms of information gaps at times of market stress.
• A full understanding of the risks requires an end-to-end examination of the structure across jurisdictions. As such, the Central Bank is cooperating with national authorities in several jurisdictions on this issue.

A Research Technical Paper by Brian Golden and Eduardo Maqui – How ‘special’ are international banks sponsoring Irish-resident SPEs? – provides new evidence on the characteristics of international banks sponsoring Irish-resident SPEs, which points to several ‘special’ features. The dataset used in the research includes 734 international banks from 19 countries covering the period Q1 2005 to Q4 2016.

The key findings are:

• These banks are larger and financially weaker across a range of indicators. These include slower growth, less profitability and lower capitalisation. They tend to have riskier loan portfolios, thinner stable sources of funding, face higher costs of funding and exhibit higher levels of indebtedness.
• Any improvements in these indicators that result from issuing debt through Irish-resident SPEs are short-term only, disappearing or reversing in the longer-term. In contrast, improvements arising from other forms of debt issuance are sustained beyond a year across almost all indicators.
• However, a key purpose of banks issuing debt through Irish-resident SPEs may be to access debt markets elsewhere. International banks markedly increase debt issuance elsewhere following their first debt issuance sponsoring Irish-resident SPEs.
• Risks within the sector are potentially heightened by the risk profile of banks that sponsor Irish-resident SPEs. These risks require close monitoring and further strengthens the need for international co-operation.

The views presented in Economic Letters and Research Technical Papers are those of the authors and do not necessarily represent the official views of the Central Bank of Ireland.

The Central Bank has today also published its latest statistics on Irish Special Purpose Entities for Q3 2018.

See our new Explainers: What is shadow banking? and What is a Special Purpose Entity?

Note

There is significant regulation of most of the shadow banking system in the EU. Within Ireland, resident money market funds, investment funds and finance companies are regulated.  Irish-resident special purpose entities are not regulated by the Central Bank as a sector, as is the case in other jurisdictions. However, the Central Bank imposes more extensive reporting requirements on special purpose entities than other jurisdictions which facilitates the monitoring of shadow banking activity.