17 June 2024

Commission: European Financial Stability and Integration Review (EFSIR) 2024

The European Financial Stability and Integration Review is published annually. It looks at recent economic and financial developments, and discusses specific issues pertaining to the financial sector that might pose challenges to financial integration and stability and raise policy issues.

Chapter 1 reports on recent economic and financial developments in the EU since 2023 up to the first quarter of 2024. Economic growth in the EU almost stagnated in 2023 as renewed geopolitical tensions, tighter financing conditions and subdued confidence weighed on economic activity. Headline inflation in the EU continued to decline over most of 2023 but increased slightly to 3.4% at the end of 2023. Gas and electricity prices are back at levels comparable with those before the recent energy crisis. Unemployment developed favourably, decreasing to 6.0% in the EU, its lowest level since the introduction of the euro.

Financial markets fluctuated considerably in 2023 on investors’ monetary expectations and macroeconomic news. Overall, sovereign bond spreads diverged across the Member States, while corporate bond spreads (particularly high-yield bond spreads) narrowed over 2023 and into early 2024. EU stock markets started positively in 2023 but were set back by the abrupt market correction in March that was set in motion by the failure of three US medium-sized banks. Equity markets later recovered. In the last months of 2023 and in early 2024, markets rose on expectations of central bank rate cuts in the months ahead.

In that context, financial stability risks surged at the end of the first quarter of 2023, with the failure of several US banks and one Swiss bank, before receding by the end of the year. Overall, the financial system has been coping well with the normalisation of interest rates and the EU banking sector in particular has benefited from increased net interest margins, while containing risks on banks’ balance sheets. Some risks nevertheless need to be monitored closely. In particular, vulnerabilities remain in the corporate sector due to tightened financial conditions and challenging macroeconomic conditions. Sovereign debt sustainability concerns have come down but remain high. Financial stability risks in commercial real estate have intensified. Rising interest rates reduced real estate valuations in some Member States and reduced the sector’s debt-servicing capacity.

EU financial integration stabilised in 2023 following a decline in 2022 that was due to Russia’s full-scale invasion of Ukraine and increased geopolitical uncertainty. Overall, financial integration has demonstrated substantial resilience in recent years in the face of major shocks, although some market segments such as banking have become more fragmented.

Chapter 2 focuses on the growth of the investment fund sector in the EU. Assets held by EU investment funds have tripled in value since the 2008 global financial crisis. This rapid rise has increased the sector’s importance for the financing of the real economy and the functioning of the financial system but has also given rise to financial stability concerns. Liquidity mismatches and leverage in this sector can contribute to or exacerbate system-wide risks to financial stability. Monitoring liquidity and leverage can help in detecting risks to financial stability in a timely manner.
As for liquidity, effective surveillance of liquidity mismatches requires financial stability indicators to be comprehensive and to take account of the potential magnitude of liquidity shocks and the mitigating effects of liquidity management tools (LMTs). The recent amendment of the EU legislative framework for investment funds (the AIFMD and the UCITSD) obliges open-ended investment funds to manage potential liquidity mismatches via at least two appropriate LMTs while money market fund managers are required to select one additional LMT.

As for leverage, risks can manifest themselves suddenly. Monitoring efforts therefore need to be sustained even if prevailing levels of leverage for most EU investment funds are currently low.

Chapter 3 analyses the reliance of EU financial services on third-country operators. This analysis confirms that the EU’s financial system is open and very interconnected with global markets. Third-country operators, especially those located in G7 jurisdictions, participate significantly in EU’s financial services markets and particularly in sectors such as commercial banking and reinsurance. Third-country operators also enjoy dominant positions in sectors such as derivatives clearing, credit ratings and card payments.

Sectors could be vulnerable if they depend too much on a limited number of providers, particularly if such providers cannot be easily replaced. When critical financial services are mainly provided by third-country operators, financial stability risks may arise (for example, in the event of abrupt termination of a business). Likewise, limited EU regulatory, supervisory and resolution powers over financial services providers located outside the EU may limit the EU’s economic and financial autonomy (for example, in the event of regulatory divergence between the EU and third countries).
Monitoring the EU’s dependencies on third countries remains important in the current context, although at present such dependencies mainly concern financial operators located in G7 partners’ jurisdictions that implement internationally agreed standards and cooperate with the EU on regulatory and supervisory matters. Risk assessments should also consider potential difficulties in replacing third-country critical providers with EU-based or other third-country providers. In addition, continuing to advance the Capital Markets Union and Banking Union, and seeking to broaden clearing capacity in the EU would increase the EU’s resilience and its ability to mobilise capital and attract foreign investment.

Commission

© European Commission