Financial stability in the euro area has benefited from an improving economic outlook, with inflation steadily declining and investor confidence recovering, according to the May 2024 Financial Stability Review released recently by the European Central Bank (ECB).

The outlook remains fragile, however, as the scope for economic and financial shocks is high in an environment of elevated geopolitical and global policy uncertainty, ECB noted.

Euro area financial stability conditions have improved as recession risks decline, but markets remain exposed to possible adverse macro-financial and geopolitical surprises, the European Central Bank said.
Tight financial conditions are testing the resilience of households, firms and governments. Asset quality, funding and revenue challenges remain for banks

“Geopolitical risks continue to cloud the outlook for financial stability,” said ECB vice president Luis de Guindos in a release.

“While financial stability conditions have improved in line with reduced recession risks and lower inflation, it remains crucial that we build further on the resilience of the financial system in the light of global economic and geopolitical uncertainty,” he added.

Financial markets remain vulnerable to further adverse shocks. While expectations of monetary policy easing have boosted optimism in investors’ risk assessments, sentiment could change rapidly, ECB noted.

Tight financial conditions continue to test the resilience of a cohort of vulnerable euro area households, firms and governments.

In aggregate, debt-to-gross domestic product ratios of euro area households and firms have declined to below pre-pandemic levels, which helps alleviate debt sustainability concerns, the bank observed.

At the same time, sovereign debt is expected to stabilise at levels that are higher than before the pandemic, rendering government finances more vulnerable to adverse shocks, it added.

Euro area banks have remained resilient, but low bank valuations suggest that investors are concerned about the durability of bank profitability.

Challenges for euro area banks may arise from three sources. First, worries about bank asset quality are growing, given signs of mounting losses in some loan portfolios that are more sensitive to cyclical downturns, notably commercial real estate.

Second, bank funding costs seem set to remain high, even if policy rates start declining.

And third, banks’ revenues may be dampened as operating income weakens due to still-muted loan growth and lower income on variable-rate loans ahead.

Fibre2Fashion News Desk (DS)

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