An Analysis of the Relationship between Captive Financial Institutions and External Lenders

This paper examines the relationship between captive financial institutions (CFIs, sector S127) and external lenders. The paper focuses on CFIs in Luxembourg that are owned by (resident and non-resident) investment funds specialising in private equity or real estate. Within the holding and acquisition structure set up by the fund sponsors, CFIs are mainly linked to other CFIs resulting in intragroup financial linkages in the form of equity holdings and intragroup loans. This is consistent with the relative importance of holding and intragroup lending companies among Luxembourg CFIs. However, certain types of CFIs have links with external lenders. This is particularly the case for conduits, entities with predominantly non-financial assets, mixed structures and extra-group loan origination companies. At the aggregate level, this means that most CFIs have little exposure to external lenders. Only a small proportion of CFIs have a higher credit exposure. The exposure is mainly to banks whose loans issued to CFIs finance mainly real estate investments (particularly commercial real estate such as office buildings and logistics facilities) located in Western Europe (mainly Germany and the United Kingdom). German banks are the main providers of loans for real estate investments, while US banks are the leading finance providers for private equity investments. The latter are broadly diversified across economic activities, with most targets located in Western Europe.
Keywords: Captive financial institutions and money lenders, Sector S127, Investment funds, Private equity, Real estate, Banks, Financial linkages
JEL codes: C80, C81, F23, F30, G23, G32