ESAs warn of risks resulting from a fragile economic outlook

The ESAs have released their Autumn 2023 Joint Committee Report on risks and vulnerabilities in the EU financial system. The report highlights a persistent high level of economic uncertainty in the European economy. It points out that recent events, such as the Russian aggression against Ukraine, the energy crisis, and turmoil in US mid-sized banks in March 2023, have contributed to this uncertainty.
One key observation is the continued sensitivity of European financial markets to external shocks, as evidenced by the banking sector turmoil in March 2023. The report warns that negative news affecting parts of the financial system can rapidly spread and increase risk aversion.
Interest rate hikes have had varying impacts on different sectors of the financial industry. While banks have seen increased net interest income, insurers have faced reduced profitability, and the asset management sector is dealing with liquidity risks.
To address these challenges, the report advises NCAs, financial institutions, and market participants to closely monitor the consequences of policy interest rate increases and sudden rises in risk premia. They should also be prepared for a potential deterioration in asset quality. Furthermore, the impact of inflation risk should be closely watched, and robust risk management and governance arrangements are essential, especially concerning liquidity risk and interest rate risk.