The three European Supervisory Authorities (ESAs) – European Insurance and Occupational Pensions Authority (EIOPA), European Securities and Markets Authority (ESMA) and European Banking Authority (EBA) – have warned financial institutions, market participants, and national supervisors against “increased vulnerabilities across the financial sectors.”
The trio advise national supervisors, financial institutions and market participants to prepare for challenges ahead in the latest issue of its Autumn 2022 joint risk report.
They said that the Russia-Ukraine War combined with disruption has “caused a rapid deterioration of the economic outlook”.
The report added, “Inflationary pressures coupled with uncertainty on risk premia adjustment raise concerns over potential further market adjustments. Rising interest rates and yields are expected to improve the earnings outlook for banks given their interest rate sensitivity.
“They could also reduce the valuation of fixed income assets, and result in higher funding costs and operating costs, which might affect highly indebted borrowers’ abilities to service their loans.”
The result is a tightening of monetary policy and an environment which will likely also have negative impact on the credit quality of financial institution loan portfolios.
The report also noted that financial institutions are faced with increased operational challenges associated with heightened cyber risks and the implementation of sanctions against Russia.
The financial system has to date been resilient despite the increasing political and economic uncertainty.
In light of such risks and uncertainties, the joint committee is advising financial institutions and supervisors to continue to be prepared for a deterioration in asset quality in the financial sector.
”Financial fragmentation, including fragmentation of funding costs, could threaten financial stability and put pressure on price stability. Inflation is not only relevant from a risk perspective, but is expected to reflect also on the actual benefits and pensions, inflationary trends should be taken into account in the product testing, product monitoring and product review phases,” the ESAs stated.