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    ECB Publishes Results of Financial Stability Review in November 2020

    November 25, 2020

    ECB published results of the financial stability review in November 2020. The financial stability review assesses the implications of the ongoing pandemic and the associated change in prospects for financial market functioning, debt sustainability, bank profitability, and the non-bank financial sector. Overall, the pandemic and its impact on macroeconomic prospects as well as sovereign, corporate, and household balance sheets continues to dominate the outlook for euro area financial stability. Macro-prudential policy must continue to focus on learning against undue deleveraging, supporting capital buffer usability, and developing an effective framework for non-bank financial sector.

    The review sets out policy considerations for both the near term and the medium term. By providing a financial system-wide assessment of risks and vulnerabilities, the review also provides key input to the macro-prudential policy stance of ECB. This issue of the review contains two special features. The first feature analyzes the synergies between enacted policies and cross-country heterogeneity as well as financial stability considerations for phasing-out of the COVID-19 relief measures. The second feature examines how the low-for-even-longer interest rate environment may affect bank lending margins and, in turn, banks’ ability to lend to the real economy and overall financial stability.

    The review highlights that vulnerabilities in the corporate sector are increasing as the pandemic evolves and their unearthing could test the resilience of euro area banks in the future. The ongoing extensive policy support is helping euro area corporates and households to cope with the fallout of the pandemic, but risks can arise either from a premature end to measures or from the prolonged support. Premature withdrawal of fiscal support, including government loan guarantees and statutory loan moratoria, could set back the economic recovery, transforming the corporate liquidity challenges observed at the outset of the pandemic turn into solvency issues. The sharp rise in corporate and sovereign indebtedness increases risks to financial stability from an emerging sovereign-corporate bank nexus in the medium-term, as banks and sovereigns alike are exposed to pandemic-induced risk faced by euro area firms.

    For euro area banks that entered the pandemic with stronger balance sheets than at the time of the global financial crisis, a premature end of government guarantees and moratoria could lead to an additional wave of losses. They are also expected to face continued pressures on profitability, including from a weaker outlook for lending and continued structural challenges. Capital buffers of banks remain comfortable and should remain available to absorb losses and support lending for an extended period. Authorities need to monitor the effectiveness of policies to support buffer use and avert deleveraging. Looking beyond the pandemic, it is important for banks, together with the rest of the financial system, to manage the financial stability risks posed by climate change and support transition to a greener economy. A return to risk-taking by non-banks, including investment funds, also increases their vulnerability to outflows and losses, should corporate credit risks rise materially. These risks are accentuated by continued gaps in the macro-prudential framework for non-bank financial institutions.

     

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    Keywords: Europe EU Banking Financial Stability Review COVID-19 Macro-Prudential Policy Systemic Risk Credit Risk Liquidity Risk ECB

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