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The ECB publishes its December 2007 Financial Stability Review which finds that the uncertainty surrounding the financial stability outlook for the euro area has heightened. The adjustment process in the financial sector over the coming months is likely to prove challenging, the ECB notes. The risks to euro area financial system stability had materially increased at the time of finalisation of this issue of the Financial Stability Review when compared to the assessment made six months ago.
Other risks that remain relevant include the substantial increase in household sector indebtedness together with signs of vulnerability in some housing markets adding to the credit risk facing euro area banks in the short to medium term.
Also, the surge of leverage in parts of the corporate sector raises the possibility of an adverse turn in the credit cycle involving a rise in the default rates of the most heavily indebted firms. Some uncertainties remain regarding hedge funds’ exposures, leverage and liquidity risk.
Finally, outside the euro area, persistently wide global imbalances continue to pose a risk that they will be unwound in a disorderly manner. This could bring about further tensions in global capital markets and, if this risk were to materialise, it could pose a challenging test for the risk management and loss-absorption capacities of key financial institutions
Dec 2007 Financial Stability review