ESAs Highlight Economic & Geopolitical Risks in Autumn 2024 Report

The European Supervisory Authorities (ESAs)—comprising the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA), and the European Securities and Markets Authority (ESMA)—have issued their Autumn 2024 Joint Committee Report, highlighting a landscape fraught with economic and geopolitical uncertainties. This comprehensive assessment underscores the pressing need for heightened vigilance across all financial market participants.

The report reveals that declining inflation rates in late 2023 and early 2024 have prompted central banks to ease monetary policies. This shift has fueled strong market performance in anticipation of rate cuts and an improving economic outlook. However, a sharp equity price dip in August serves as a stark reminder of the volatility and unpredictability inherent in today's financial environment.

Despite expectations of falling interest rates, they are likely to remain elevated compared to pre-pandemic levels. Geopolitical events—ranging from the ongoing Russian aggression in Ukraine to conflicts in the Middle East and escalating tensions between China and Taiwan—pose significant risks. Recent European parliamentary elections have already triggered initial market volatility, illustrating how geopolitical uncertainties can swiftly impact financial markets.

In response to these risks, the Joint Committee has outlined several critical policy actions:

1. Prepare for High Interest Rates: Financial institutions and supervisors should brace for the continued impact of high interest rates on the real economy. Elevated refinancing costs will challenge both markets and the real economy, especially for firms with high debt and weak cash flows.
2. Monitor Credit Risks: Ongoing vigilance is essential regarding credit risk. Institutions must ensure adequate provisioning and up-to-date collateral valuation, while transparency for non-bank lenders needs improvement.
3. Enhance Flexibility: Financial institutions must be agile and prepared for unexpected short-term challenges, particularly those arising from geopolitical risks. Effective planning and process management are crucial.
4. Address Inflation Impacts: Financial institutions should consider inflationary trends in product development, particularly in insurance where timely premium repricing is critical. Supervisors must ensure that consumers are aware of inflation's effects on returns and retirement income.
5. Strengthen Cyber Risk Management: The report highlights the growing threat of cyberattacks, exacerbated by geopolitical tensions. Institutions should adopt comprehensive cybersecurity measures, including risk management, incident reporting, and threat-led penetration testing.

The report also delves into sector-specific issues, such as:

• Banking Sector: EU/EEA banks saw a rise in profitability in 2023 due to increased net interest income. However, profitability has begun to decline, and banks must remain cautious with payouts amid ongoing risks.
• Insurance Sector: European insurers maintained solid capitalization in 2023, but geopolitical risks could affect their risk assessment, pricing decisions, and investment strategies. The ongoing Insurance Stress Test Exercise aims to assess the sector's resilience.
• Pension Funds: Occupational pension funds have remained resilient despite inflationary pressures. However, the increase in liabilities has slightly outpaced asset growth, indicating potential concerns.
• Investment Funds: Positive performance in early 2024 was driven by bond fund inflows, but the weakening credit quality of high-yield bonds raises concerns about future market corrections.

The Autumn 2024 Joint Committee Report emphasizes the need for robust GRC frameworks in navigating a landscape marked by significant economic and geopolitical uncertainties. The ESAs' recommendations call for proactive measures and strengthened risk management to ensure financial stability and compliance in these challenging times.

In line with the evolving financial landscape, the European Banking Authority (EBA) has recently launched its annual transparency exercise for 2024, a cornerstone of EU banking supervision since 2011. This year's initiative is particularly significant as it sets the stage for the 2025 stress tests by offering a comprehensive snapshot of over 100 major EU banks' health. By evaluating key indicators such as capital positions, profitability, and risk exposures, the EBA aims to enhance transparency and bolster confidence in the EU financial system.

This exercise, grounded in standardized supervisory reporting data, not only reinforces the importance of accurate regulatory reporting but also provides stakeholders with the tools to assess the sector's resilience amidst ongoing economic uncertainties and geopolitical tensions. The results, set to be published alongside the Risk Assessment Report (RAR) at the end of November, will be crucial for shaping future regulatory decisions and risk management strategies, highlighting the need for robust governance frameworks in a time marked by financial volatility and risk.

The ESAs’ recommendations highlight the necessity for financial institutions to remain vigilant and proactive, especially in managing high interest rates, credit risks, and inflation impacts. The emphasis on robust cybersecurity measures and sector-specific insights further reinforces the need for comprehensive risk management strategies. As the EBA’s annual transparency exercise sets the stage for upcoming stress tests, it becomes evident that the path forward requires not only heightened awareness but also strategic foresight and meticulous planning. The report serves as a pivotal reminder that in an environment characterized by volatility and uncertainty, a strong governance and compliance infrastructure is essential for ensuring financial stability and confidence in the EU’s financial system.

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