ESAs published a Joint Committee report on risks and vulnerabilities in the EU financial system. The report highlights uncertainties about the terms of the Brexit and describes the policy actions being called for by ESAs.
In light of the ongoing uncertainties, especially those around Brexit, supervisory vigilance and cooperation across all sectors remain key. Therefore, ESAs call for the following policy actions by European and national competent authorities as well as financial institutions:
- Contingency Plans—It is crucial that EU financial institutions, market participants, and their counterparties enact timely contingency plans to prepare for Brexit, including possible market volatility a no-deal Brexit may trigger. ESAs are closely monitoring Brexit developments and the possible associated risks of a no-deal scenario. In this regard, ESAs issued opinions and recommendations to provide important guidance for financial institutions, market participants, and national competent authorities.
- Stress Tests—Against the backdrop of the potential for sudden risk premia reversals with a risk of rising funding costs, the development and regular use of stress tests across all sectors remain crucial. Therefore, scenarios for the 2018 bank and insurance stress tests, which are conducted by EBA and EIOPA, reflected these risks. Furthermore, ESMA will present guidelines on fund liquidity and Money Market Fund stress testing during 2019. ESMA is also preparing its next central counterparties (CCPs) stress test. EBA has started to prepare the methodology for its 2020 stress test exercise and EIOPA launched its 2019 Occupational Pensions Stress Test.
- Lending by Banks—Banks should develop strategies to carefully manage and address large refinancing needs, including building loss-absorbing capacity. In addition, banks should continue with efforts to address the stocks of non-performing loans (NPLs) and should review their business model to improve profitability. Banks must also carefully manage their credit risk and interest rate risk. New bank lending has started to increase and warrants close monitoring of credit quality trends of new lending portfolios. Banks need to ensure that lending standards and covenant requirements do not weaken. The financial sector and banks, in particular, need to carefully manage their sovereign exposure, which might imply a significant impact on their profitability and capital.
- Insurance Sector—Supervisors and insurance companies must ensure that risks of a potentially sudden reassessment of risk premia and continued low interest rates are properly monitored and analyzed while taking appropriate mitigating actions. In this context, the vulnerabilities identified in the 2018 insurance stress test by EIOPA need to be addressed.
Keywords: Europe, EU, Banking, Securities, Insurance, Brexit, Stress Testing, NPLs, ESAs
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