EBA欧洲银行-JC-Risks-and-Vulnerabilities-Report-28JC-2016-172920Spring-2016_13页_633kb

Summary of the Joint Committee Report on Risks and Vulnerabilities in the EU Financial System (March 2016)

Core Content

This report outlines the key risks and vulnerabilities facing the EU financial system, focusing on low profitability in a low yield environment, increasing interconnectedness among financial institutions, and the potential contagion from China and other emerging markets.

Main Risks and Vulnerabilities

1. Low Profitability in a Low Yield Environment

• Low interest rates: Yields in Europe remain at historical lows across various fixed income instruments, including sovereign and corporate bonds, money market instruments, and asset-backed securities.
• Negative yields: A significant portion of short-dated instruments offer negative yield-to-maturity, reflecting the impact of the low yield environment.
• Credit risk premia: Credit spreads have narrowed, and the average credit quality of outstanding debt securities has declined, contributing to reduced profitability.
• Impact on investment funds: Investment fund returns dropped significantly in the second half of 2015, with equity and commodity funds experiencing sharp declines.
• Insurance sector challenges: Insurers face lower investment returns, particularly life insurers with old contracts offering high guaranteed returns.
• Bank profitability: While banks saw an improvement in ROE (from 5.4% to 6.4% in Q3 2015), profitability still does not meet long-term sustainability levels.
• Supervisory needs: Forward-looking supervisory approaches are required to assess the sustainability of business models, especially in light of new impairment requirements under IFRS 9.

2. Interconnectedness within the Financial System

• Role of non-bank and non-insurance financial institutions (NBNIFIs): These entities are becoming more significant in the financial system, increasing interconnectedness and complexity.
• Systemic relevance: Interconnectedness is a key factor in the propagation of shocks, contributing to systemic events. Regulators must consider this when assessing systemic risk.
• Capital Market Union (CMU): The EU Commission's plan for CMU aims to enhance market-based funding and financial intermediation, potentially reducing reliance on traditional banking.
• Repo transactions: These short-term instruments, with high liquidity, contribute to interconnectedness within and between financial institutions.
• Network analytics: Evidence shows a shift in the nature of interconnectedness, with asset managers now influencing the performance of banks and insurers more than before.

3. Risks from China and Emerging Markets

• Economic slowdown: Emerging markets, particularly China and Brazil, have started to experience economic slowdowns, which may impact the EU through trade and reduced confidence in global recovery.
• Negative impact on EU: The slowdown in EM could lead to reduced demand for EU exports and lower global economic confidence, affecting European financial markets and institutions.
• Market volatility: The potential for contagion from EM is a concern, especially given the high correlation in asset prices observed in H2 2015.

Key Recommendations

• Supervisory approaches: Supervisors should adopt forward-looking methods to assess business model sustainability, particularly in the context of low profitability and capital requirements.
• Risk management: Institutions should maintain prudent credit standards and risk control measures, especially as they seek higher yields in a low interest rate environment.
• Monitoring interconnectedness: Regulators need to closely monitor ancillary risks such as concentration risks, cross-border exposures, and regulatory arbitrage.
• Fintech oversight: The increasing role of financial technology requires close supervision to understand and mitigate potential risks, including investor protection, operational risk, and macroprudential risks.
• Enhanced transparency: Disclosure standards for investment products, including UCITS and retail products, should be improved to ensure investors are aware of risks and costs.
• Stress testing: EIOPA and EBA will conduct stress tests to evaluate the resilience of the EU financial system to low yields and adverse market conditions.

Conclusion

The report emphasizes the need for a comprehensive and proactive supervisory approach to address the evolving risks and vulnerabilities in the EU financial system. The combination of low yields, low profitability, and increasing interconnectedness presents significant challenges that require coordinated regulatory and supervisory responses to ensure financial stability.