European Central Bank highlights shrinking liquid asset buffers in euro area investment funds and insurers

The European Central Bank, in analysis published in its Financial Stability Review, finds that non-banks’ liquid asset holdings have continued to decline, with the share of cash equivalents and high-quality liquid assets (HQLA) Level 1 falling substantially in both investment funds and insurance corporations over the past four years. The ECB links the trend to reduced capacity to meet margin calls or redemptions under stress, increasing the risk that non-banks sell illiquid assets on unfavourable terms and transmit stress across markets. The decline in the most liquid assets is attributed to valuation changes and portfolio rebalancing towards non-HQLA assets. For investment funds, the falling share of cash and HQLA Level 1 reflects relatively higher valuation gains on HQLA Level 2 equity holdings, growing investment in other non-HQLA assets, and valuation losses on HQLA Level 1 bond holdings as interest rates rose from 2022. Insurers experienced similar bond valuation effects and also shifted away from cash equivalents towards investment fund shares, notably equity fund shares. The ECB cautions that aggregate HQLA can overstate usable liquidity in stress, as HQLA Level 2 equities may suffer sharp losses and be saleable only at significant discounts, and haircut-based measures aligned with the EU HQLA framework indicate that readily available liquidity has continued to fall; it also flags that liquidity accessed via fund shares may be uncertain in stress, creating potential contagion channels between non-bank sectors that require further monitoring.