The ECB warns of the fragile outlook for financial stability due to the worsening of the economy

MADRID, 22 Nov.

The ECB warns of the fragile outlook for financial stability due to the worsening of the economy


The prospects for financial stability in the euro zone remain fragile, as tighter financial conditions increasingly bite into the real economy amid weak growth, high inflation and heightened geopolitical tensions, the Bank has warned. European Central Bank (ECB).

"The weak economic outlook together with the consequences of high inflation are testing the ability of people, companies and governments to pay their debt," said the Vice President of the ECB, Luis de Guindos, in the presentation of the Report. of Financial Stability.

In this sense, the document warns that financial markets and non-banking financial institutions continue to be very sensitive to new negative developments and their vulnerabilities could be exposed to negative surprises in economic conditions.

At the same time, it considers that investment funds and other non-bank financial institutions remain vulnerable to liquidity, credit and leverage risks, highlighting the need to strengthen their resilience from a macroprudential perspective.

Likewise, the ECB warns that while tighter financial and credit conditions are increasingly translating into higher debt service costs, "the full impact on economic activity has not yet materialized," given the general extent of loan maturities in all economic sectors when interest rates were very low.

In this way, the central bank points out that both the financial and non-financial sectors could face challenges in the future as these costs increase and warns that the effect "is already visible in the real estate sector of the euro zone", which They are experiencing a recession.

"In residential property markets, the fall in prices has been driven by deteriorating affordability as mortgage financing costs rise," the ECB notes.

In the case of commercial real estate markets, the entity notes that the effects of increased financing costs have been reinforced by structurally lower demand for office and retail properties after the pandemic.

Regarding the banking sector, the report highlights that banks in the euro zone have proven to be resistant to crises since the pandemic and their profitability has been increasing.

However, it warns that eurozone banks face headwinds from an expected rise in funding costs as they gradually pass on higher interest rates to depositors and the composition of their funding shifts away from deposits. demand towards more expensive term deposits or bonds.

Furthermore, the ECB notes that bank asset quality can be expected to be affected by a combination of higher debt servicing costs and a weak macroeconomic environment, as well as the impact on bank profitability of the substantial fall in Loan volumes stemming from higher interest rates coupled with lower demand for loans and tighter credit standards.

Despite these threats, the ECB concludes that, overall, the euro zone banking system "is in good condition to withstand these risks", highlighting that macroprudential authorities have increased reserve requirements in recent months to strengthen the banks.

Thus, to help safeguard the resilience of the financial system, the ECB recommends that macroprudential authorities should maintain capital buffers alongside existing borrower-based measures that ensure sound credit standards to make it easier for banks to navigate the turn of the cycle. financial.

However, it considers it essential that the remaining Basel III reforms are faithfully implemented and that the banking union is completed, adding that a comprehensive and decisive policy response is required to address structural vulnerabilities in the non-banking financial sector, arising e.g. of liquidity risk or leverage, to improve the resilience of the financial system.

"It is essential that we remain alert as the economy moves into an environment of higher interest rates along with growing uncertainties and geopolitical tensions," Guindos added.