Publication Alert: ESAs - Report on Risks and Vulnerabilities in the EU Financial System
We communicate that the European Supervisory Authorities (ESAs) has published a Report on Risks and Vulnerabilities in the EU Financial System.
1. Context
In August 2024, the Joint Committee (JC) on Risks and Vulnerabilities in the EU Financial System released a report addressing the economic uncertainties and financial challenges stemming from recent geopolitical events, inflation fluctuations, and market volatility. Despite optimism from anticipated interest rate cuts, geopolitical tensions and macroeconomic instability pose significant risks. These uncertainties necessitate vigilance and preparedness from financial institutions across the EU, particularly as inflation and interest rates remain elevated compared to pre-pandemic levels.
In this context, The ESAs have issued their Autumn 2024 JC Report, which addresses risks and vulnerabilities in the EU financial system. The Report highlights persistent high economic and geopolitical uncertainties. It warns national supervisors of the financial stability risks arising from these uncertainties and calls for ongoing vigilance from all financial market participants. In addition, for the first time, the Report also includes a cross-sectoral analysis of credit risks within the financial sector.
2. Main points
- Monetary and geopolitical risks. Despite declining inflation and market expectations for rate cuts, ongoing geopolitical tensions (e.g., Russia-Ukraine war, US-China tensions) could cause sudden shifts in economic outlooks. EU financial markets saw a strong first half in 2024, but August’s market volatility highlights the potential for rapid changes.
- Credit risk. Credit risk remains a significant concern, especially for high-yield corporates, small and medium enterprises (SMEs), and sectors like real estate. Non-performing loans (NPL) have increased, especially in the real estate sector. Higher refinancing costs, particularly for high-yield corporate debt, could lead to increased defaults in vulnerable sectors.
- Private credit and non-bank lending. Private credit has expanded rapidly, particularly in sectors like professional services and technology. However, its opaque nature could pose systemic risks, especially during economic downturns. Enhanced transparency and scrutiny of lending standards in private credit markets and non bank lending are crucial to mitigating these risks.
- Operational risks. Cyber risks are heightened due to increased geopolitical tensions, with financial sector entities facing growing threats. The sophistication of cyberattacks has increased, underscoring the need for holistic risk management approaches.
3. Next steps
The JC recommends that financial institutions:
- Remain vigilant to continued interest rate and refinancing pressures, especially for vulnerable firms with weak cash flows.
- Strengthen monitoring and management of credit risk, ensuring adequate provisioning and up-to-date collateral valuation.
- Address cyber risks holistically, leveraging the Digital Operational Resilience Act (DORA) and other regulatory frameworks.