The euro zone’s financial sector is in better health now than at any time in the last two years, the European Central Bank said Wednesday in its half-yearly Financial Stability Review.
The ECB took much of the credit for this improvement itself. “ECB policies, in particular the Outright Monetary Transactions program that effectively eliminated the perceived tail risk of a euro area break-up, have been key–but not the only positive development,” it said in an overview of its report.
The announcement of the OMT program in August, under which the ECB would buy on the open market bonds of countries that had asked for, and were deemed to be complying with, euro-zone rescue aid packages, drove a five-month rally in bonds previously seen as too risky.
The announcement appeared to convince financial markets that market pressure alone wouldn’t be allowed to drive Italy and Spain, the euro zone’s third and fourth-largest economies, out of the currency union.
The ECB also supported its mainly upbeat conclusions by pointing to the “muted” market reactions to more recent political shocks.
“Financial market participants seem to have increasingly internalised the commitment of the political authorities, at European and national level, to ensure the stability of the single currency and its banking and financial markets,” it summed up.
Although its overriding message was upbeat, the ECB warned that a number of risks were still rising. It said the biggest single risk was that the weak economy would create further credit losses at banks, eroding their profitability and the capital cushions that they have built up over the last two years.
“The risks of rising non-performing loans eroding profitability is most relevant for banks with exposures to highly indebted households and firms, vulnerable to adverse developments in the form of falling or subdued commercial and residential property prices, rising unemployment or weak economic demand,” the ECB said.
It also highlighted concerns–”justified or not”–that banks have been presenting their accounts in a too-flattering way, discouraging any return of confidence in the sector.
The ECB urged banks to make “adequate provisions” against non-performing assets “as well as any other foreseeable expense”, such as litigation costs.
It is still unclear to say, for example, how much banks will have to pay for past manipulation of benchmark interest rates and various mis-selling practices. The ECB had already warned about that risk in its last FSR in December.
In the new edition, however, it included for the first time in its list of key risks the chance of a shake-out in global markets driven by a “reassessment of risk premia”.
The ECB appeared concerned by market imbalances created by a period in which some participants have pursued safety at any price, pushing the returns on some safe government debt below zero, while others have ventured into more and more risky products in a “hunt for yield”.
The ECB used the report to repeat again its belief that the euro zone must make quick and comprehensive progress towards creating a banking union: a message it has been at pains to communicate in recent weeks, as euro-zone governments and the European Commission have appeared to back-pedal on more initial plans for a common mechanism for resolving failed banks.
Among the other key risks it identified, the ECB singled out the risk that the slow pace of political reform in some countries could trigger a fresh crisis of confidence in the region’s sovereign debt markets.
The warning comes on the day that the European Commission softened its application of the Excessive Deficit Procedure as countries such as France, Spain and the Netherlands all struggle to bring their budget deficits down to agreed levels.
wsj.com
The ECB took much of the credit for this improvement itself. “ECB policies, in particular the Outright Monetary Transactions program that effectively eliminated the perceived tail risk of a euro area break-up, have been key–but not the only positive development,” it said in an overview of its report.
The announcement of the OMT program in August, under which the ECB would buy on the open market bonds of countries that had asked for, and were deemed to be complying with, euro-zone rescue aid packages, drove a five-month rally in bonds previously seen as too risky.
The announcement appeared to convince financial markets that market pressure alone wouldn’t be allowed to drive Italy and Spain, the euro zone’s third and fourth-largest economies, out of the currency union.
The ECB also supported its mainly upbeat conclusions by pointing to the “muted” market reactions to more recent political shocks.
“Financial market participants seem to have increasingly internalised the commitment of the political authorities, at European and national level, to ensure the stability of the single currency and its banking and financial markets,” it summed up.
Although its overriding message was upbeat, the ECB warned that a number of risks were still rising. It said the biggest single risk was that the weak economy would create further credit losses at banks, eroding their profitability and the capital cushions that they have built up over the last two years.
“The risks of rising non-performing loans eroding profitability is most relevant for banks with exposures to highly indebted households and firms, vulnerable to adverse developments in the form of falling or subdued commercial and residential property prices, rising unemployment or weak economic demand,” the ECB said.
It also highlighted concerns–”justified or not”–that banks have been presenting their accounts in a too-flattering way, discouraging any return of confidence in the sector.
The ECB urged banks to make “adequate provisions” against non-performing assets “as well as any other foreseeable expense”, such as litigation costs.
It is still unclear to say, for example, how much banks will have to pay for past manipulation of benchmark interest rates and various mis-selling practices. The ECB had already warned about that risk in its last FSR in December.
In the new edition, however, it included for the first time in its list of key risks the chance of a shake-out in global markets driven by a “reassessment of risk premia”.
The ECB appeared concerned by market imbalances created by a period in which some participants have pursued safety at any price, pushing the returns on some safe government debt below zero, while others have ventured into more and more risky products in a “hunt for yield”.
The ECB used the report to repeat again its belief that the euro zone must make quick and comprehensive progress towards creating a banking union: a message it has been at pains to communicate in recent weeks, as euro-zone governments and the European Commission have appeared to back-pedal on more initial plans for a common mechanism for resolving failed banks.
Among the other key risks it identified, the ECB singled out the risk that the slow pace of political reform in some countries could trigger a fresh crisis of confidence in the region’s sovereign debt markets.
The warning comes on the day that the European Commission softened its application of the Excessive Deficit Procedure as countries such as France, Spain and the Netherlands all struggle to bring their budget deficits down to agreed levels.
wsj.com
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