The European Central Bank (ECB) warns that “the prospects for financial stability in the euro area are fragile in the context of recent banking tensions outside the monetary union.”
The ECB has published this Wednesday the semi-annual report on financial stability, in which it analyzes the impact of the crisis of some banks in the United States and Switzerland on the banking sector in the euro zone.
“Eurozone banks have reacted resiliently to recent tensions outside the eurozone, but higher funding costs and lower asset quality may affect their profitability,” the report says.
“Although economic conditions have improved slightly, uncertain growth prospects, together with persistent inflation and more restrictive financial conditions, are weighing on the balance sheets of companies, families and governments,” adds the ECB.
In addition, adds the ECB, “an unexpected deterioration in economic conditions or a further tightening of financial conditions could lead to disorderly price adjustments in financial and housing markets.”
ECB Vice President Luis de Guindos said at the presentation of the report that “price stability is crucial for lasting financial stability.”
Eurozone companies, in particular, are facing tighter financial conditions and uncertain business prospects, which can be difficult, especially for companies that have taken on deep debt and reduced profits during the pandemic.
In addition, high inflation is hurting households, especially those with lower incomes, reducing their purchasing power and jeopardizing their ability to repay loans.
“Demand for new loans, especially mortgages, fell sharply in the first quarter of 2023, in response to rising interest rates,” Guindos said.
The recent fall in energy prices has reduced the pressure on governments to find additional budget support, but public authorities face increasing financing costs.
The ECB notes that house prices in the euro area have corrected their prices, that the rise in house prices has cooled down considerably in recent months and that, consequently, the overvaluation of the sector has been reduced.
So far, the price adjustments have been orderly, but they could turn messy if rising mortgage rates dampen demand.
Commercial real estate markets remain depressed due to rising interest rates and an uncertain economic outlook.
“The current correction could test the resistance of investment funds with interests in the commercial real estate sector,” adds the ECB.
Financial markets and investment funds are vulnerable to asset price adjustments.
Overvaluations, tighter financial conditions, and reduced market liquidity can increase the risk of disorderly price adjustments, especially if a recession occurs.
So far, mutual funds have been largely unaffected by the tensions in the US and Swiss banking sectors.
“But this could change if the funds suddenly need liquidity and are forced to sell assets quickly,” according to Guindos.
Eurozone banks have resisted tensions from US and Swiss banks because “their exposures are limited.”
This resilience was supported by its strong capital and liquidity positions and the work of banking supervisory authorities in recent years.
For this reason, the ECB considers it essential to “preserve this resilience” at a time when it is more difficult for some banks to accumulate capital, since interest rates reduce banks’ lending volumes and increase their financing costs, which That can reduce your profitability.
The ECB also draws attention to the fact that there are already signs of deterioration in the quality of loan portfolios exposed to commercial real estate, small business and consumer credit.
As a result, some banks will need to have more funds available to cover losses and manage their credit risks.
In this sense, the ECB also considers it essential to complete the banking union, in particular, to establish a common European deposit insurance.
Source: TSF
