Financial stability: the role of pension funds

Linda Fache Rousová*Financial Stability Expert

DG Macro‐prudential Policy and Financial StabilityEuropean Central Bank

*Disclaimer: This presentation should not be reported as representing the views of the European Central Bank (ECB). The views expressed in this presentation are those of the author and do not necessarily reflect those of the ECB.

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“Systemic risk can best be described as the risk that the provision of necessary financial products and services by the financial system will be impaired to a point where economic growth and welfare may be materially affected.[…]Financial stability is a state whereby the build-up of systemic risk is prevented.”

Financial stability and systemic risk?

Source: ECB Financial Stability Review, May 2017

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Financial stability: Macroeconomy, financial institutions and financial markets

Source: Moenjak (2014)

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Financial stability: The role of pension funds?

Pension funds

Direct effect on macroeconomy:PFs’ financial health contribution/ entitlements domestic demand

Indirect effect on macroec.:Instability in the fin. marketspotential sales by ICPFs financial market instability &funding to macroeconomy

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How to measure the role of PFs for financial stability?

Source: Beetsma, Vos and Wannigen (2017)

Direct effect(macro-economic risk)

Indirect effect(systemic risk)

Mechanism Depressing domestic demand,either through higher contributions or lower entitlements

Instability in the (relevant segment of the) financial markets

Relevant size pension sector

Large relative to GDP Large relative to financialmarkets(s) invested in

Size distribution pension sector

Policy measures at large pension funds have higher macroeconomic impact

Concentrated pension fund investment portfolios have more potential for causing instability

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ICPF financial assets in relation to GDP (2016; percentages)

Measure I: Size relative to GDP

Source: ECB (ICPF balance sheet and Euro Area Accounts data).

Total financial assets of euro area ICPFs (2008-2016; EUR trillions)

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2008 2009 2010 2011 2012 2013 2014 2015 2016

insurance corporationspension funds

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LU NL IE FR EA DE BE IT PT AT ES FI CY SI EE SK LV LT GR

insurance corporationspension funds

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Question 1: Which financial markets are ICPFs invested in?

Measure II: Size relative to financial market(s) invested in

Source: ECB Securities Holdings Statistics.

Euro area ICPF’s securities holdings (2016 Q3; percentages)A. Main asset classes B. Debt securities broken down by maturity

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Question 2: What is the importance of ICPFs in these markets?

Measure II: Size relative to financial market(s) invested in, cont’d

Source: ECB (Euro Area Accounts data).

Debt securities issued by euro area sectors (EUR trillion, 2016 Q4)

Euro area ICPFs hold 21%of debt securities issued byeuro area sovereigns

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Government bonds Bank bonds Corporate bonds Other bonds

Euro area ICPFsEuro area banksEuro area investment fundsOther euro area sectorsNon-euro area

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Recent trend: search for yield? Holdings of debt securities broken down by rating (2013 Q4 - 2016 Q4, percentages of total holdings)

A. Insurance corporations B. Pension funds

Note: Credit quality steps are defined in accordance with the Eurosystem credit assessment framework (ECAF), which provides a harmonised rating scale classifying ratings into three credit quality steps

(step 1: securities rated from AAA to AA-; step 2: from A+ to A-; step 3: from BBB+ to BBB-; step 4: rated securities with a rating below credit quality step three).

Source: ECB Securities Holdings Statistics.

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credit quality step 1credit quality step 2

credit quality step 3credit quality step 4

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credit quality step 1credit quality step 2

credit quality step 3credit quality step 4

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Key points

- Pension funds play an increasingly important role for financial stability

- In some euro area countries, this is because of their large and increasing size (NL!)

- More importantly, pension funds are large institutional investors, heavily invested in fixed income assets and exposed to interest rate risk

- To the extent that pension funds act pro-cyclically they can exacerbate financial market volatility

- Close monitoring of the sector from financial stability perspective is warranted, especially as its size and role tend to increase over time