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The challenges to financial stability are increasing given the downside risks to the economic outlook



PRESS RELEASE

29. May 2019

  • The occurrence of downside risks to economic growth could lead to greater volatility in the financial markets.
  • Ongoing downside risks to growth add to the need to strengthen the balance sheets of highly indebted companies and governments. [19659004] Banks' profitability prospects are cautious given slow progress in tackling structural issues

"If downside risks to growth prospects, risks to financial stability may arise," said Luis de Guindos, ECB vice-president. "The growth prospects are central to all material risks to financial stability."

Uncertainty about the outlook for global economic growth has contributed to seizures of high volatility in the financial markets. Weaker-than-expected growth and a potential escalation of trade volatility could lead to a further decline in asset prices, warns the FSR.

The risk of revaluation seems to be particularly high in the riskier segments of the corporate sector. The global leveraged loan sector, which has grown significantly in recent years, is vulnerable to weaker corporate earnings. The FSR outlines how this sector could pose risks to financial stability, especially given the uncertainties surrounding the final exposure to the riskiest parts of secured loan commitments.

If downside risks to growth materialize, financing costs for vulnerable countries are likely to rise, raising concerns about the sustainability of debt. In addition to the high level of debt and high budget deficits, in some countries risks of rollover could occur if market participants reassess country risk.

The profitability of euro area banks is likely to remain low. Estimates from the ECB assume a total return on equity of around 6% over the next 2-3 years. A large proportion of euro area banks will not be able to meet investors' expected returns (around 8-1

0%). However, the capital adequacy of banks in the euro area remains high, implying widespread resilience to plausible adverse scenarios. Notwithstanding this short-term resilience, the FSR emphasizes that changing the credit outlook in the medium term could lead to higher financing costs for banks. In order to return to sustainable profitability, euro area banks must face a number of structural challenges such as low cost efficiency, limited diversification of revenues and a still high level of existing installations in some countries.

high risk in the non-bank and fund sector. There are signs that more funds are increasing their leverage and exposure to high-yielding assets with correspondingly higher credit risk. A renewed sudden revaluation of financial assets could trigger large outflows and possibly lead to forced asset sales by mutual funds, increasing stress in less liquid markets.

This edition of the FSR contains three specific features, including one dealing with the financial aspects of climate change stability challenges, including the measurement of risks arising from physical manifestations of climate change and transitional risks towards achieving internationally agreed ones Refer to climate goals.

For media inquiries, please contact William Lelieveldt, Phone: +49 69 1344 7316.

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