Financial regulators should incorporate synthetic risk transfers into system-wide stress tests to better assess potential contagion risks between banks and non-bank financial institutions, according to a new Bank for International Settlements report. The Bank for International Settlements paper, co-authored by Michael Chui and Costas Stephanou, warns that while these instruments currently represent only about 2% of total bank loans in major markets, their fivefold growth since 2016 warrants closer scrutiny.

Banks use synthetic risk transfers to boost solvency ratios and reduce reliance on equity issuance, with Banco Santander SA, Barclays Plc, and BNP Paribas SA among the most active issuers. The instruments have facilitated the redistribution of risk from banks to non-bank financial institutions, deepening sector linkages. However, limited public disclosure and data gaps raise concerns about hidden vulnerabilities building unnoticed as structures become more complex.

Central banks are increasing monitoring of these transfers as part of broader efforts to identify connections between banks and so-called non-bank financial institutions, which often face less stringent regulation. The Basel-based institution highlights risks including the repackaging of SRT investments into new financing vehicles and the use of debt leverage by investors to boost returns. While current risks appear modest, the report emphasizes the need for enhanced monitoring and cross-border information-sharing on investor funding structures and inter-linkages.