European Authorities Decry ‘Rapid Deterioration of Economic Outlook'

On Monday, the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA) warned financial institutions, market participants and national supervisors against “increased vulnerabilities across the financial sectors.”

A joint committee of the European supervisory authorities in a statement urged the industry stakeholders to prepare for the challenges ahead.

The committee in their Autumn 2022 Joint Risk Report noted that the Russia-Ukraine War combined with disruption to trade has “caused a rapid deterioration of the economic outlook.”

These added to pre-war inflationary pressures, have increased the risk of persistent inflation and stagflation in the continent, they said.

As a result, the authorities explained that the volatility of the financial market has increased across the board.

They explained: “After a long period of low-interest rates, central banks are tightening monetary policy.

“The combination of higher financing costs and lower economic output may put pressure on government, corporate and household debt refinancing while also negatively impacting the credit quality of financial institutions’ loan portfolios.

“The reduction of real returns through higher inflation could lead investors to higher risk-taking at a time when rate rises are setting in motion a far-reaching rebalancing of portfolios.”

Policy Actions

In the statement, the supervisory authorities advised financial institutions and supervisors to continue to be prepared for deterioration in asset quality in the financial sector.

They noted that this preparation should cover assets that enjoyed temporary measures designed to cushion the impacts of the COVID-19 pandemic.

Assets that are vulnerable to dire economic conditions, inflation, high energy costs and commodity prices are also to be accounted for in preparatory efforts.

“The impact of further increases in policy rates and of potential sudden increases in risk premia on financial institutions and market participants at large should be closely monitored,” they said.

Furthermore, they urged financial institutions to closely monitor the impact of inflation risks and the dangers they pose to retail investors.

With regards to the retail investors, they noted that risk monitoring is particularly more important for crypto-assets and other products for which consumers may not fully understand the level of risks involved.

“Financial institutions and supervisors should continue to carefully manage environmental risks and cyber risks to address threats to information security and business continuity,” the supervisory authorities added.