In Europe, financial stability is at risk and could collapse under the weight of unresolved fragility and vulnerability: the analysis is from the ECB, which announced the May financial review.
The financial stability in the Eurozone is fragile and exposed to vulnerabilities and shock risks: this is the latest warning from the ECB, which has just announced the Financial Stability Review of May.
Specifically, financial markets could suffer a sharp decline due to further negative events in the global economy. In its financial stability review in May, the Eurotower concluded that prospects for euro area stability remained dim after the recent turmoil in the banking sector, which saw several US regional banks fail and the emergency takeover of Credit Suisse by UBS.
There are at least 3 serious reasons to fear a collapse of financial stability in Europe. For the ECB, therefore, prudence must still guide forecasts and asset and operations management, especially for banks.
Why Europe’s financial stability is on the alert
In its financial stability review, the ECB warned of the fragility of the Eurozone system for at least 3 reasons, listed in the official document:
- Tighter financial conditions test household, business, government and housing markets resilience;
- Financial markets are vulnerable to disorderly adjustment, given the vulnerabilities of investment funds, excessive valuations, high volatility, and low liquidity;
- Euro area banks are resilient to recent stresses outside the euro area, but higher funding costs and lower asset quality could weigh on profitability.
In summary, rising interest rates test the resilience of households, businesses, governments, and housing markets, all of which leave investors potentially exposed to messy adjustments.
While banks have thus far been remarkably resilient to the recent turmoil in the US and Switzerland, higher funding costs and lower asset quality could still dent their profitability.
There are some crucial issues in the central bank’s sights. First, “Euro area firms are facing stricter financing conditions and uncertain business prospects”. This can translate into serious difficulties (or bankruptcies) for firms with high debts and fragile earnings, especially after the pandemic crisis.
At the household level, excessively high prices impoverish already low-income households, “reducing their purchasing power and jeopardizing their ability to repay loans. Demand for new loans, particularly mortgages, fell sharply in the first quarter of 2023 in response to rising interest rates”.
Particular attention is paid to the real estate market. House prices have cooled markedly in a relatively short period of time and could plummet further if higher mortgage costs continue to reduce demand.
At the same time, the commercial real estate markets remain in decline because of tough financing conditions, an uncertain economic outlook, and weaker post-pandemic demand. Such a correction could test investment funds’ resilience.
“The correction in housing markets could get messy in the event of negative macro-financial surprises”, the report said.
Finally, a warning to banks. Across all these challenges, the resilience of euro area banks has been remarkable, but it should not give way to complacency according to De Guindos.
Lenders have been supported by strong capital and liquidity positions which now need to be preserved. Authorities should maintain extremely cautious capital buffers, while some countries may also consider targeted increases.
Finance in Europe is about maximum prudence. Collapse risks are still too high.
Original article published on Money.it Italy 2023-05-31 14:18:29. Original title: La stabilità finanziaria in Europa sta per crollare?
