15 June 2009

ECB Financial Stability Review - June 2009

The ECB is concerned should the global economic downturn prove to be deeper and more prolonged than currently expected. Uncertainty prevails about the shock-absorption capacity of the euro area banking system.

Policy-makers and market participants will have to be especially alert in the period ahead, the ECB warns. The risks for financial stability remain high, especially since the credit cycle has not yet reached a trough.

 

Hard-to-value assets have remained on bank balance sheets and the marked deterioration in the economic outlook has created concerns about the potential for sizeable loan losses. Uncertainty prevails about the shock-absorption capacity of the euro area banking system.

 

The ECB is concerned that many of the risks identified in this issue of the FSR could materialise if the global economic downturn proves to be deeper and more prolonged than currently expected. In particular, the main risks identified within the euro area financial system include the possibility of:

Ø       a further erosion of capital bases and the risk of a renewed loss of confidence in the financial condition of LCBGs;

Ø       significant balance sheet strains emerging among insurers; and

Ø       more widespread asset price declines coupled with high volatility.

 

Outside the euro area financial system, important risks include the possibility of:

Ø       US house prices falling further than currently expected;

Ø       the economic downturn in the euro area being even more severe than currently projected; and

Ø       an intensification of the stresses already endured by central and eastern European countries.

 

Banks will need to be especially careful in ensuring that they have adequate capital and liquidity buffers to cushion the risks that lie ahead, while providing an adequate flow of credit to the economy, the report states. Over the medium to longer term, banks should undertake the appropriate restructuring to strengthen their financial soundness and resilience to shocks.

 

Given the risks and challenges that lie ahead, banks should improve and diversify their medium-term funding, enhance their shock-absorption capacities and protect sound business lines from the contagion risks connected with troubled assets.

 

Press release

Speech Papademos

 

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