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October 30, 2018

ECB published the annual report that assesses risks in the banking sector. The three most important risk drivers identified for 2019 are geopolitical uncertainties, legacy and potential future non-performing loans (NPLs), and cybercrime and IT disruptions. These are followed by repricing in financial markets, low interest rate environment, and banks’ reaction to regulation.

The results of the risk assessment exercise highlights that the work so far has led to a significant progress in reducing NPLs. The NPL ratio of significant institutions decreased from 8% in 2014 to 4.9% in the fourth quarter of 2017. Nevertheless, the aggregate level of NPLs remains high compared to international standards and further efforts are necessary to ensure that the NPL issue in the euro area is adequately addressed. High stocks of NPLs constrain balance sheets, profitability, and capital of banks. Therefore, addressing legacy NPLs, including the monitoring of banks’ progress to reduce NPLs, remains among the key priorities of the European banking supervision. In addition, the ongoing search for yield might increase the potential for a build-up of future NPLs.

The report also highlights that the risk of an abrupt and significant repricing in financial markets has increased since last year. Banks would be affected mostly through their holdings of instruments recognized at fair value, collateral requirements, and costs to raise capital or liquidity. In an extreme case, if a major repricing coincided with other major events, it could also threaten the solvency of central counterparties, thus posing a systemic risk. As most of the post-crisis financial regulatory initiatives are being finalized, the pace of regulatory reform has somewhat slowed. However, some regulations still need to be implemented into the EU law. While regulatory uncertainty has decreased, banks need to further adapt their business models to operate in the new environment. Tighter regulation helps to safeguard a resilient and stable banking system in the medium and long term. In the short term, however, tighter regulation can challenge the profitability of banks and impose banking-sector risks, such as banks failing to adapt on time or postponing strategic decisions and/or investments

ECB Banking Supervision conducts a risk identification and assessment exercise on an annual basis in close cooperation with national competent authorities. The analysis draws on inputs from a wide range of contributors, including the Joint Supervisory Teams and horizontal micro-prudential and macro-prudential functions. It is also informed by discussions with banks and other relevant authorities. The outcome of this exercise serves as a basis for defining supervisory priorities and determines focus areas for the regular monitoring and analysis of risks to which the supervised banks are exposed.

 

Related Link: Risk Assessment for 2019 (PDF)

Keywords: Europe, EU, Banking, Securities, NPLs, SSM, Cyber Risk, Climate Related Risks, ECB

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