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Low growth and low yield environment
Low growth and low yields affect the financial services industry through various channels. Interest rates and growth expectations have decreased further and are posing new challenges to the entire financial sector. Low interest margins significantly constrain banks' profitability, while life insurers' and pension funds' liabilities increase as it becomes more difficult to generate high investment returns. This environment may lead banks, insurers, pension funds and other investors to engage in risky search-for-yield behaviour, adding to already elevated risks around asset valuation and adjacent concerns about market liquidity.
The Joint Committee considers it essential to further develop effective recovery and resolution schemes in all relevant sectors, to employ adequate stress testing procedures and to enhance the monitoring of relevant risk drivers.
Profitability of financial institutions
Low quality of assets in many countries, conduct costs and growing competition from non-bank and non-insurance financial institutions negatively affect the profitability of banks and insurers. Subdued returns, further lowered by fees and charges, reduce the attractiveness of investment funds. While the EU-wide bank stress test results have demonstrated the importance of a better capitalised banking system, the high levels of non-performing loans (NPLs) exacerbate concerns about medium-terms sustainability. Addressing NPLs as a major driver of uncertainties in the financial system has become a key challenge, and further NPL resolution requires comprehensive and proactive action among all relevant stakeholders. Following the UK referendum, profitability risks may be further intensified. Expectations of weaker macroeconomic conditions are amplified by growing political risks within the EU and globally. In addition, traditional financial service providers are facing increasing competition from Fintech providers which will further challenge the sustainability of their business models.
Responding to this risk, supervisors need to encourage steps to adjust business models in search for sustainable income, to address excess capacities as well as to monitor and assess the impact of emerging innovative technologies and market practices.
Interconnectedness within the financial system
The interconnectedness between the financial sector outside of the banking, insurance and pension fund industries with the wider financial system is increasing, as cross-sectoral exposures, asset price commonalities and the interdependency of business processes augment.
The Joint Committee considers that related stability risks should be assessed thoroughly to mitigate the increasing risk exposure outside the traditional financial system.
Joint Committee Risk Report - Autumn 2016