05 September 2013

European Supervisory Authorities highlight cross-sectoral risks

The Report has identified the following key cross-sectoral risks to the stability of the European financial system:

• the weak macro-economic outlook;
• the protracted low-interest rate environment;
• EU financial sector fragmentation; and
• reduced confidence in balance sheet valuations and risk disclosures.

These risks, already highlighted in the first Joint Committee's Risk Report published in April this year, have increasingly been brought into focus following a series of developments that took place since then. In particular, increased volatility in longer-term interest rates and concerns about the future path of interest rates - combined with the current low interest rate environment - created uncertainty for financial institutions in their hedging and impacted profitability.

When it comes to cross-border banking activity, there is strong evidence of a fragmented European financial sector, and in particular of a material scale back of intra-EU cross-border lending into economies experiencing sovereign stress or recession. There is also uncertainty on the timely and proper recognition of losses that are embedded in portfolios of financial assets. Market uncertainties regarding perceived inconsistencies in the calculation of banks' risk weighed assets (RWAs) have further affected the perception of EU banks. Conduct of business risks also continues to be a concern from both a conduct and prudential perspective.

Since the previous publication in April 2013, some important policy milestones reinforcing the EU financial regulation have been reached. These address a number of the concerns mentioned above, and include the adoption of the Capital Requirements Directive and Regulation, the Council's general approach on a framework for Banking Recovery and Resolution, and, in particular, the agreement on establishing the Single Supervisory Mechanism (SSM) for banks. Prior to starting the SSM, action will be taken across the EU in order to address uncertainties in balance sheet valuations.

In addition, ESMA and the EBA have also developed a series of Principles for Benchmark-Setting Processes in the EU which aim to address public concerns about these widely used benchmark setting processes, while EIOPA continued to work with national supervisory authorities on their responses to a prolonged low interest rate environment and delivered its technical advice on the way forward for the introduction of the Solvency II long-term guarantee package.

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