ECB Financial Stability Review: Financial stability vulnerabilities have eased

Euro area financial stability conditions have improved as recession risks decline

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

Geopolitical risks continue to cloud the outlook for financial stability

It remains crucial that we build further on the resilience of the financial system in the light of global economic and geopolitical uncertainty.

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. 

Acute geopolitical stress could spark volatility, creating the potential for outsized market reactions that could be amplified by non-banks with structural liquidity fragilities.

Debt-to-GDP ratios of euro area households and firms have declined to below pre-pandemic levels, which helps alleviate debt sustainability concerns. 

Sovereign debt is expected to stabilize at levels that are higher than before the pandemic, rendering government finances more vulnerable to adverse shocks. 

Debt service costs may still rise across all economic sectors going forward, as maturing liabilities continue to reprice at prevailing, significantly higher interest rates. 

A downturn is under way in property markets. The commercial segment in particular is continuing to experience a substantial price correction, and further declines cannot be excluded. By contrast, residential property markets are showing some signs of stabilization after what has so far been an orderly price correction.

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. Second, bank funding costs seem set to remain high. 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.

Overall, the euro area banking system is well-equipped to weather these risks, given strong capital and liquidity positions.