Despite the recovery in financial markets, there are several grounds for caution in assessing the outlook for financial stability in the euro area, including vulnerabilities being revealed in non-financial corporations’ balance sheets, government indebtedness raising and leverage ratio.
Despite the recovery in financial markets and improved financial performance of euro area LCBGs (large and complex banking groups), there are several grounds for caution in assessing the outlook for financial stability in the euro area. In particular, the main risks identified outside the euro area financial system include the possibility of:
- vulnerabilities being revealed in non-financial corporations’ balance sheets, because of high leverage, low profitability and tight financing conditions;
- greater-than-expected household sector credit losses if unemployment rises by more than expected;
- the surge of government indebtedness raising concerns about the sustainability of the public finances, as well as the crowding out of private investment; and
- an adverse feedback between the financial sector and public finances as a result of financial system support measures, fiscal stimuli and weak economic activity.
Within the euro area financial system, important risks include the possibility of: renewed financial strains and that the recent recovery of bank profitability will not prove durable;
- vulnerabilities of financial institutions associated with concentrations of lending exposures to commercial property markets and to central and eastern European countries being unearthed; and
- a setback for the recent recovery of financial markets, if macroeconomic outcomes fail to live up to optimistic expectations.
To cushion the risks that lie ahead, banks will need to be especially mindful in ensuring that they have adequate capital and liquidity buffers in place. If the circumstances require it, some banks may need to raise new and high-quality capital. In addition, some banks, especially those which have received state support, may need fundamental restructuring in order to confirm their long-term viability when such support is no longer available. This could involve the shrinking of balance sheets through the shedding of unviable businesses with a view to enhancing their profit-generating capacities. At the same time, banks should take full advantage of the recent recovery in their profitability to strengthen their capital positions, so that the necessary restructuring of businesses and the enhancement of shock-absorbing capacities do not impinge materially on the provision of credit to the economy.
© ECB - European Central Bank
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