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November 28, 2018

ECB published results of the financial stability review in November 2018. The financial stability review assesses developments relevant for financial stability, including identifying and prioritizing the main sources of systemic risk and vulnerabilities for the euro area financial system. This review plays an important role in relation to the micro-prudential and macro-prudential competences of ECB. By providing a financial system-wide assessment of risks and vulnerabilities, the review provides key input to the macro-prudential policy analysis of ECB.

In addition to the usual overview of the current developments relevant for euro area financial stability, the review includes eight boxes and three special features aimed at deepening the financial stability analysis of ECB and broadening the basis for macro-prudential policy making. The first special feature examines how banks can reach sustainable levels of profitability. The second feature examines the financial stability implications stemming from a resurgence of trade tariffs while the third one discusses the rapid growth in exchange-traded funds and their potential for transmitting and amplifying risks in the financial system.

The review highlights that the profitability of euro area significant banks remained broadly stable in the first half of 2018. Structural vulnerabilities, including overcapacity in certain domestic banking markets and high operating costs, continue to dampen bank profitability. Reductions in non-performing loans (NPLs) continued, with the NPL ratios of banks having nearly halved since 2014. Moreover, banks’ solvency positions remain solid. The recent EBA stress test confirmed that the capitalization of euro area banks is sufficient to weather a severe adverse scenario. Additional sensitivity analyses to account for the recent developments, not specifically catered for in the test, lead to an additional capital depletion of about 30 to 70 basis points, on top of the overall common equity tier 1 ratio depletion of 380 basis points in the adverse scenario of the EBA stress test.

The assessment shows that, looking ahead, four key risks to euro area financial stability could materialize over the next two years. First, the most prominent risk stems from the possibility of a disorderly increase in global risk premia. Second, the risk of renewed debt sustainability concerns has increased over the last six months. Third, legacy issues from the financial crisis continue to dampen bank profitability and could hamper banks’ intermediation capacity. Fourth, possible liquidity strains in the investment fund sector constitute a growing risk. 

 

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Keywords: Europe, EU, Financial Stability Review, Stress Testing, NPLs, Systemic Risk, Macro-prudential Policy, ECB

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