The European Central Bank (ECB) published the financial stability review for November 2021. The assessment report highlights that the near-term pandemic-related risks to financial stability have declined as economy rebounds. However, tighter macro-prudential policies can help address growing vulnerabilities, notably those in the housing markets in some countries. It will also be essential to enhance the regulatory framework for the financial sector, including full, timely implementation of the Basel III reforms and a stronger policy framework for the non-bank financial sector.
Market sentiment toward euro area banks has remained favorable, as the near-term profitability outlook has improved. Looking ahead, bank profitability remains hampered by structural challenges of euro area banks. Bank profitability has improved overall since the start of 2021 on the back of lower loan loss provisions and stronger revenue streams from investment banking, but the profitability outlook continues to depend on the path of overall economic recovery and the pandemic. While the non-performing loan (NPL) ratio has dropped to levels last seen before the global financial crisis on account of further progress made in NPL sales, asset quality concerns may resurface as government support measures are gradually withdrawn, reinforcing the need for effective NPL solutions. The risk of price corrections has also increased in some real estate and financial markets. Vulnerabilities in residential real estate markets have grown, especially in countries with valuations that were already elevated prior to the pandemic.
Consolidation via mergers and acquisitions (M&A) could be one potential avenue for helping the sector to return to more sustainable levels of profitability. Looking ahead, euro area banks also face increasing urgency to meet digital transformation needs and to manage the implications of the transition to a greener economy. The review notes that climate change-related vulnerabilities call for policies to support an orderly transition. The financial stability review also contains the following three special features:
- The first special feature analyzes bank lending behavior during the pandemic to gain insights into banks’ propensity to use capital buffers and the impact of the regulatory capital relief measures implemented by the authorities. The micro-econometric analysis performed in this special feature shows that the banks that had limited capital space above regulatory buffers adjusted their balance sheets by reducing lending which could be interpreted as an attempt to defend capital ratios. This suggests that they were unwilling to use capital buffers. While more research is desirable, also on macro aspects, these findings suggest that more releasable capital could enhance macro-prudential authorities’ ability to act countercyclically when a crisis occurs.
- The second special feature is focused consolidation in the banking sector. Most M&A activity has had a domestic focus and has involved smaller targets and consolidation seems, on average, to have had a moderately positive impact on the profitability of the banks involved. The analysis notes that cross-border M&A transactions have been concentrated within a few small groups of euro area countries, supported by prior financial links and geographical proximity. Such transactions tend to be followed by a stronger improvement in profitability than domestic mergers, although this effect has diminished since the global financial crisis.
- The third special feature is focused on creditor coordination in resolving non-performing corporate loans. This special feature proposes a strategy to overcome creditor coordination failures and costs, through the use of data platforms providing ex ante transparency to NPL investors. These, together with NPL securitization, could substantially reduce the gap between the value of the loans carried on banks’ balance sheets and the prices offered by investors for NPL portfolios.
Keywords: Europe, EU, Financial Stability Review, COVID-19, Financial Stability, Macro-Prudential Policy, NPLs, Credit Risk, Basel, Banking Union, Transition Risk, Climate Change Risk, ECB
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