The Joint Committee of European Supervisory Authorities (ESAs) published its second 2021 joint risk assessment report for the financial sector. In the report, ESAs note that COVID-19 crisis has acted as a catalyst for digital transformation, highlight risks in phasing out of the crisis measures, and call on financial institutions to adapt to increasing cyber risks. The assessment also focuses on risks related to the increased risk-taking behavior evident from the rising prices and volumes traded on crypto-assets and the continued concerns about the sustainability of current market valuations. ESAs note that policymakers, regulators, financial institutions, and supervisors can start reflecting on lessons learned from the COVID-19 crisis.
The report highlights concerns related to credit risk and notes that a wide range of policy responses were introduced in response to the crisis to provide breathing space to struggling borrowers and businesses. In the banking sector, these include public guarantee schemes on loans and moratoria on loan repayments. As these schemes are temporary only, banks need to withstand possibly increasing credit risk losses upon their expiry. The increased interconnectedness between the financial sector, corporates, and governments might be a further concern, enforced by a potentially uneven recovery across sectors and regions. In the banking sector, the previously expected increase in credit losses has not yet materialized, though asset quality indicators of loans under support measures additionally show a deteriorating trend. This may indicate risks of asset quality deterioration and increasing credit losses still to come and may require banks to increase provisioning levels, especially since uncertainties on the further course of the pandemic and the economic environment remain. Meanwhile, cyber risk is noted by the financial institutions and supervisors as an important operational risk and, in this context, the report discusses various regulatory initiatives underway in financial sector in European Union to address this risk. It also notes that the costs of cyber incidents coupled with a tightening in data protection regulation worldwide could boost cyber insurance demand.
In light of these risks and uncertainties, in the report, ESAs advise national competent authorities, financial institutions, and market participants to take the following policy actions:
- Supervisors should continue to closely monitor asset quality and provisioning in the banking sector, in particular of assets under support schemes; this includes identifying possible practices of under-provisioning. Such monitoring is an important prerequisite when coordinating the unwinding of the various support measures.
- As the economic environment gradually improves, focus should shift to allow a proper assessment of the consequences of the pandemic on lending books of banks and banks should adequately manage the transition toward the recovery phase. Banks and borrowers experiencing financial difficulties should proactively work together to find appropriate solutions for their specific circumstances; this should include not only financial restructuring, but also a timely recognition of credit losses.
- Disorderly increases in yields and sudden reversals of risk premia should be closely monitored in terms of their impacts for financial institutions as well as for investors. Supervisors, policy makers, and financial institutions should also continue to develop further actions to accommodate a “low-for-long” real interest rate environment and risks its entails against the background of rising in inflation. This includes addressing overcapacities in the financial sector.
- Financial institutions and supervisors should continue to carefully manage their information and communication technology and cyber risks. They should ensure that appropriate technologies and adequate control frameworks are in place to address threats to information security and business continuity, including risks stemming from increasingly sophisticated cyber-attacks. The report notes the importance of conducting resilience testing in proportion to the risks faced and of swiftly putting in place a European Union-wide common framework for digital operational resilience, including the proper management of risks around outsourcing.
Keywords: Europe, EU, Banking, Insurance, Securities, Risk Assessment Report, Cyber Risk, ICT Risk, COVID-19, Credit Risk, NPLs, Lending, Credit Loss Provisioning, Loan Moratorium, Public Guarantee Schemes, ESAs
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