Risks and challenges of complex financial instruments: an analysis of SSM banks

In the Occasional Paper n. 417 we investigate the valuation risk affecting financial instruments classified as L2 and L3 for accounting purposes. These are instruments that are not directly traded in active markets and are often relatively complex, opaque and illiquid.

There is a huge volume of L2 and L3 instruments in the balance sheets of SSM banks (around €6.8 trillion worth, considering both assets and liabilities). We highlight that these instruments share some characteristics with NPLs (illiquidity, opacity), and argue that the risk they pose might also be comparable.