vitor constancio : macroprudential stress - tests and tools for the non - bank sector remarks by mr vitor constancio, vice - president of the european central bank, at the european systemic risk board ( esrb ) annual conference, frankfurt am main, 22 september 2017. * * * 1. introduction : systemic risks in the non - bank sector assessing the impact of a large shock on financial soundness of non - bank financial institutions, stress testing can improve measurement of the risks and can help in the calibration of instruments mitigating those risks. there is a need to further develop these policy tools while at the same time adaptation of stress test models towards integrating different agents into a system - wide tool is important. the esrb – in its strategy paper on macroprudential policy beyond banking1, for example, emphasises the need to develop a wider financial stability toolkit, including top - down stress tests, for example, for asset managers, the need to operationalise macroprudential instruments for which a legal basis has already been created or the need to investigate the potential for increasing the consistency of available macroprudential instruments across sectors. 2 in its report on stress test analytics for macroprudential purposes in the euro area, the ecb also outlines the plans for extending stress testing into other sectors, most prominently the shadow banking sector, but also into the stress testing of central counterparties and insurance and pension funds. 3 let me first set the stage by reiterating the two main systemic risks stemming from the non - bank financial sector. first, the increasing size and growth of the euro area investment fund sector has the potential to amplify financial stability risks, both in terms of liquidity and leverage. as an example of the structural change in the european financial sector, it is worthwhile noting that the size of the money market and investment fund sector represented only 17 % of banks ’ total assets in 2008 but is now at 40 %. whereas the banking sector shrank by 18 % since the crisis, the fund sector more than doubled since 2008. the continued inflows into bond funds for example, may raise concerns about sudden redemptions in response to a more widespread repricing in global fixed income markets, if it were to occur. large redemption calls can have widespread amplification effects in financial markets. there are signs that fixed income investment funds have increased their risk taking in recent years via a higher asset allocation to lower -

behaviours of different types of agents and on analysing the increasing pool of data. one enhancement is about fire sales mechanisms stemming from interactions between banks and shadow banks. 9 another example worth mentioning is about systemic aspects of liquidity and its links with solvency conditions accounting for pertinent interactions between market participants captured in an agent - based modelling fashion. 10 though, what is still required is further strong support from the research community to provide theoretical foundations for the various components of the stress test apparatus. 3. macroprudential tools to address the risk stemming from the non - bank sector despite these limitations, we should also note the progress made in understanding how stress testing exercises, in particular, have the potential to support macroprudential policy in the design, calibration and assessment of the impact of macroprudential tools. let me now turn to the state of play regarding the implementation and progress made for some of the specific macroprudential instruments that authorities would need, should systemic risks materialise. on the global level, the 2017 fsb policy recommendations on asset management structural vulnerabilities11, now being operationalised by iosco, are expected to reduce liquidity mismatches in open - ended funds. importantly, recommendation 8 captures the potential macroprudential role for authorities to provide direction on the use of liquidity risk management tools ( e. g. suspension of redemptions ) by funds in extraordinary circumstances. in the area of liquidity mismatch, the recommendations also address the potential use of system - wide stress testing by authorities. leverage recommendations focus on the measurement and monitoring of leverage within investment funds, including data for synthetic leverage calculation. on the european level, on - going work of the expert group on investment funds ( egif ) develops recommendations that are addressed to funds and asset managers. given that the investment fund sector is growing relative to the financial system as a whole, the esrb is analysing systemic risks posed by liquidity mismatch and leverage in the types of investment funds exposed to these risks. to highlight the importance of this work, let me preview results of an ecb occasional paper12 to be published soon. the study shows, for a large sample of european alternative investment funds ( aifs ), that open - ended leveraged funds experience greater investor outflows after bad performance than unleveraged funds. this can be explained by investors expecting proportionally larger valuation losses when remaining invested in leveraged funds.