14 November 2007

ECB report on EU banking sector stability

The ECB published a report on EU banking sector stability. The report notes that the financial condition of the EU banking sector continued to develop positively throughout 2006. Differences in the pace at which IFRS are being introduced for supervisory purposes in individual countries complicate the analysis.

The latest market turmoil is likely to have repercussions on the earnings of many EU banks in the second half of 2007. The sound profitability of EU banks over several consecutive years should have generated adequate buffers against both expected and unexpected losses.

Among the main vulnerabilities for EU banking sectors is the likely evolution of the credit cycle – which could be affected by the recent re-pricing of credit risk, should it prove lasting – and its impact on borrowers’ credit quality and banks’ credit risk. The rise in demand for liquidity, in the context of the recent turmoil, has also increased concerns about banks’ liquidity and credit commitments, which has underlined the importance of banks’ liquidity risk management, including stress-testing and contingency planning.

In addition, for large banks in particular, there are uncertainties about the extent to which their financial performance could be impaired by declining revenues from non-interest income sources if, for instance, activity in the market for securitised loans were to remain depressed for a more protracted period.

Finally, the continued expansion of foreign currency lending to households in some EU countries could be posing increasing risks to the banks involved if housing market developments are reversed in the countries affected or if exchange rate volatility increases.

The forward-looking assessment based on market indicators suggests that near-term risks facing the banking sector have increased. Uncertainties among market participants about the banking sector’s earnings prospects have also increased, and this could be further aggravated by unexpected developments in the US sub-prime mortgage market and if the problems in structured credit markets were to spill over to the broader credit and capital markets.

Press release

Full report

© Graham Bishop