EU Watchdogs Warn Financial Stability Risks Remain Elevated

The European Supervisory Authorities (EBA, EIOPA and ESMA) issued their Spring 2024 joint risk update recently, warning that risks remain elevated across the EU financial sector amid slowing economic growth, uncertainty around interest rates, and ongoing geopolitical tensions.

While financial markets have rallied in anticipation of potential interest rate cuts later this year, the authorities cautioned that this increases the risk of market corrections if events unfold differently than expected. Credit risks are also projected to rise as refinancing needs grow, especially for lower-rated corporate debt and real estate.

In the banking sector, asset quality is expected to deteriorate as economic growth slows further, though banks currently report solid capital levels with an average CET1 ratio of 15.8% and ample liquidity buffers. Profitability was high in 2023, but the outlook is more challenging with the repricing of assets and liabilities potentially squeezing net interest income.

The insurance industry maintained strong solvency ratios above 200% in 2023, and pension funds improved their financial position. However, subdued growth and the potential for a repricing of risk premiums pose ongoing challenges.

For investment funds, while they have navigated the transition to higher rates, there are lingering concerns around real estate valuations and liquidity risks that could have broader spillover effects.

Geopolitical instability and reliance on digital finance have heightened cyber risks, with the number of attacks increasing. While impacts have been limited so far, cyber insurance claims are rising. Banking cyber resilience test results expected soon will shed more light on this threat.

Overall, the European authorities painted a picture of resilient but vulnerable financial system facing an array of risks from the economic slowdown, market volatility, and cyber threats amidst geopolitical turmoil. They urged continued vigilance from institutions and supervisors.

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