The Joint Committee of the European Supervisory Authorities has published a report on risks and vulnerabilities in the EU financial system. The Joint Committee highlights the following main risks to the EU financial system, which it explains have persisted over a relatively long period and result from the lasting effects of the 2007/8 financial crisis:
- low growth and low yield environment: on the valuation side, lower interest rates tend to support prices of financial assets, as long as expectations for future corporate revenues remain largely intact. Uncertainties around the future relationship between the UK and the EU and related political process intensified concerns with regard to asset price misalignment;
- profitability of financial institutions: low interest rates, in conjunction with profitability issues, create incentives to engage in search for yield across the financial sector. Capitalisation and profitability challenges for the banking and insurance sectors are increasing, while for banks, interest income remains under pressure. For life insurers and pension funds, low interest rates increase the market value of their liabilities, and make it more challenging to generate high investment returns without taking undue risk. Technological innovation, supporting new business opportunities and new business entrants, has the potential to improve productivity, reduce costs in the long term and increase benefits to consumers, but may also lead to increased competition and could further impact the profitability of financial entities going forward; and
- interconnectedness within the financial system: the financial system beyond banks, insurers and pension funds continued to grow with the interconnectedness of funds, other financial entities not belonging to banking, insurance or pension fund sectors and market infrastructures with the wider financial system increasing, thereby also intensifying related risks. This triggered increased supervisory interest in the scrutinizing of opportunities for stress testing exercises for non-banking entities such as investment funds.
View ESAs’ Joint Committee report on cross-sector risks facing EU financial system: August 2016, 7 September