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Many of the risks arise from the still weak EU macro-economic outlook, which affects the financial positions of governments and private sector borrowers and the outlook for property markets, and which may lead to further deterioration in the profitability and asset quality of banks, insurers and other financial market participants. Policy announcements by European leaders – especially on Outright Monetary Transactions (OMT) and the Single Supervisory Mechanism (SSM) – have significantly reduced market perceptions of tail risks and led to a narrowing of bank and sovereign credit spreads. But truly to break the bank-sovereign link and create foundations for sustainable macro-economic growth will require continued progress on implementation of announced policies. Financial regulations (including Solvency II and CRR/CRD-IV) must remain economically and actuarially sound to promote a stable financial system that can sustainably provide financial services to the real economy and view risks consistently across balance sheets.
Financial market participants remain concerned about the balance sheet valuation and risk disclosures of financial institutions, and value the equity of many EU financial institutions at a significant discount to their book values. Financial institutions should value all their assets and liabilities properly, in full accordance with applicable accounting standards and regulations, to ensure valuation consistency within the EU, and should also analyse and understand the sources of valuation uncertainty. This uncertainty affects both banking book and trading book assets, and ultimately the valuation of capital. Supervisors are strongly encouraged to monitor and review the quality of banks’ assets and the practises of banks to measure the quality of their assets. A particular problem for the insurance sector (due to delays to IASB convergence work and Solvency II) is the continued absence of EU-harmonised accounting standards and regulatory valuation rules. Valuation and risk measurement (especially of complex instruments and longer term risks) is generally based on quantitative models. For assets and risks where firms use similar or identical models, they are consequently exposed to risks of valuation shocks arising from model failures and recalibrations. Additionally, much of the valuation uncertainty relates to financial institutions exposures to the aforementioned common risk factors of macro-economic outlook, interest rates and collateral values. Supervisors are encouraged to set appropriate incentives to correct for potential distortions to valuation and to contribute by these means to the ultimate goal of the protection of consumers and investors.
Confidence in financial market benchmarks suffered in 2012, as previous misconduct in banks’ submission of benchmark interest rates came to light. ESMA and EBA have acted, in coordination with the EU Commission, IOSCO and national authorities, to address the flaws in benchmark rate setting for Euribor and other key benchmarks. While more work needs to be done in designing sustainable resilient solutions for setting of financial benchmarks, continuity of existing benchmarks (which are referenced by an enormous number and value of financial contracts) also needs to be maintained, e.g. by mitigating the risk of disruptive withdrawals from existing rate-setting panels.
EBA press release © EBA