Europe faces ‘serious risks’ to financial system, regulators warn

Europe’s top financial regulators have issued an unprecedented warning of ‘serious risks to financial stability’ after concluding that Russia’s invasion of Ukraine could create a toxic combination of economic slowdown, falling asset prices and tensions in the financial markets.

The European Systemic Risk Board, which is responsible for monitoring and preventing dangers to the region’s financial system, has published the alert after meeting last week and deciding that the energy crisis triggered by the war in Ukraine had put the financial system in a precarious position. This is the first “general warning” on the risk issued by the ESRB since its creation in 2010 on the eve of the sovereign debt crisis in the euro zone.

The authority, chaired by European Central Bank President Christine Lagarde, called on regulators in the 30 countries it oversees to prepare for a potential crisis by requiring the financial institutions they oversee to build up reserves capital and larger provisions capable of absorbing losses.

The ESRB warning was agreed on September 22, days before the unorthodox decision by the new UK government. tax plans caused turmoil in financial markets and forced the Bank of England to intervene by buying bonds. People briefed on the ESRB discussions said the UK’s issues were not part of the discussions, but acknowledged they were likely to be an additional concern for regulators in Europe now.

Concerns about the health of Europe’s financial system have grown since the conflict in Ukraine pushed energy prices higher, pushing inflation to multi-decade highs, prompting central banks to aggressively raise rates interest rate and triggering a sell-off in the bond and stock markets.

“Rising geopolitical tensions have led to higher energy prices, causing financial hardship for businesses and households still recovering from the adverse economic consequences of the Covid-19 pandemic,” the ESRB said. “Furthermore, higher than expected inflation is tightening financial conditions.”

He identified three main sources of systemic risk: “The deterioration of the macroeconomic outlook, the risks to financial stability stemming from a (possible) sharp correction in asset prices and the implications of these developments for the quality of assets”.

The housing market – a recurring concern for the ESRB – was always a potential weakness, he said. “Rising mortgage rates and deteriorating debt-servicing capacity due to lower real household income can be expected to put downward pressure on property prices and lead to a materialization of cyclical risks,” he warned.

He also listed the increased risk of default in the commercial real estate sector, cyberattacks on financial institutions and the rising cost of high government debt as interest rates rise, among other topics. of concern.

Europe’s financial system emerged relatively unscathed from the pandemic, but that was largely due to strong support from governments and central banks for households and businesses.

The ESRB has warned that the likelihood of “tail risk scenarios” has increased since the start of the year, pointing out that property prices have been rising at a rapid pace for years and that overall debt levels in Europe had jumped by almost a fifth since the start of 2020 to reach 27.5 billion euros.

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Don F. Davis