European Supervisory Authorities warn of risks across the financial sector

The three European Supervisory Authorities – European Banking Authority, European Insurance and Occupational Pensions Authority and the European Securities and Market Authority (EBA, EIOPA and ESMA – ESAs) issued their first joint risk assessment report for 2022, highlighting the increasing vulnerabilities across the financial sector as well as the rise of environmental and cyber risks.

The report notes that Russia’s invasion of Ukraine and its economic consequences have aggravated the outlook for growth and inflation and brought heightened market volatility.

It added that market resilience will critically depend on the ability of markets and financial institutions to deal with the economic consequences of the war, and to withstand changes in public policy support on the monetary or fiscal side without material disruptions.

The recovery of the European Union (EU), which had been predicted last year, now appears to have been hindered by new waves and variants of the virus, concerns regarding inflation risk, rising commodity prices and heightened geopolitical risks.

It also said that additional vulnerabilities and risks for the financial system have built up over time. Financial markets remain vulnerable to changes in market sentiment, particularly if financial conditions tighten unexpectedly due to inflation pressures

At the same time, the financial sector is increasingly exposed to environmental risks and risks stemming from digitalisation.

Against this backdrop, the ESAs advises financial institutions to “be prepared for further potential negative implications stemming from geopolitical tensions and ensure compliance with the sanctions regimes put in place both at the EU and at global levels.”

It also said that they and supervisors should “prepare for a possible deterioration of asset quality in the financial sector.

In addition, the impact of further increases in yields and sudden reversals in risk premia on financial institutions and investors should be closely monitored.

It also recommends financial institutions to further embed ESG considerations to be further into their business strategies and governance structures.

Moreover, given the elevated level and frequency of cyber incidents, “financial institutions should strengthen their cyber resilience and prepare for a potential increase in cyberattacks,” according to the report.

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