(Bloomberg) -- European banks need to improve their ability to manage the risks they face in dealing with clients such as hedge funds, according to a top regulatory official. 

“There are some banks where we see major deficiencies, we don’t see remediation, we don’t see appropriate follow-through,” Elizabeth McCaul, a member of the European Central Bank’s Supervisory Board, said in a speech Wednesday. “Also in general when I look at the whole portfolio across the board, there are still a few major areas, even the banks that are conducting remediation, where we do feel the banks need to step up their work in this area.”

Regulators are pushing banks to improve their grasp of counterparty credit risk after incidents including the 2021 implosion of Archegos Capital Management showed lenders can be burned by their clients’ troubles. Federal Reserve Vice Chair for Supervision Michael Barr said Tuesday that banks should bolster how they assess the credit risk of trading partners and their leverage.

Read more: Banks Must Do More on Counterparty Risks, Fed’s Barr Says

McCaul said European banks have developed remediation plans in this area with deadlines ranging between the third quarter of last year and the end of 2025. By the end of 2023, “roughly one-third of the corrective actions had already been taken,” she added.

Speaking at a conference organized by the Federal Reserve Bank of New York, McCaul cited the following areas for improvement:

  • Stress testing “especially for high-risk clients that are vulnerable to tail risk events and potential close-out risk”
  • Better risk metrics for capturing illiquid, concentrated positions and the costs of winding down portfolios
  • “Regular fire drills” for banks to test their preparedness for dealing with a counterparty defaulting.

McCaul said the ECB is focused on the “broad range of ever-changing counterparty credit risks” that banks face, not just exposure to prime brokers or hedge funds, private equity or private credit funds.

The ECB’s work suggests that certain financial institutions outside of banking may also “have been taking risks that make them more vulnerable to market shocks and, therefore, those are ones that merit greater scrutiny,” she said.

Read more: Hedge Funds, Non-Banks Can Pose Systemic Risks, FDIC Chief Says

She also said there were “worthy discussions” among authorities about whether non-bank financial institutions required new rules. McCaul cited the lack of a “full picture of how risk transformation may be occurring and correlation risks may be developing outside of our supervisory remit.”

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