ECB warns 'we're not out of the woods' on financial stability risks

Photo: EPA ECB Vice President Luis de Guindos

The 19 nations that share the euro are facing financial risks that are elevated and uneven, the European Central Bank warned Wednesday. Therefore, more targeted stimulus could be required as the region recovers from the coronavirus crisis.

The pandemic has hit different economic sectors with varying degrees of severity and speed, with tourism and hospitality among the most impacted. In its latest financial stability review, the ECB warned that this uneven shock is concentrating risks in very specific nations and parts of the euro zone economy.

“It is a bittersweet message,” ECB Vice President Luis de Guindos said regarding the latest assessment.

“The evolution of the vaccination (program) is very positive, we are catching up and this is, you know, very good news. But simultaneously, well, we continue having some financial stability risks that we need to monitor,” de Guindos told CNBC’s Joumanna Bercetche Wednesday.

The euro zone’s central bank is particularly concerned about a higher corporate debt burden in countries with larger services sectors, because this could increase pressure on governments and lenders in these nations. This could be a headache in the short term as governments lift their pandemic-related stimulus, such as furlough programs.

“As this support is gradually removed, considerably higher insolvency rates than before the pandemic cannot be ruled out, especially in certain euro area countries,” the ECB said in a statement.

When speaking to CNBC, de Guindos said that “2020 is a little bit of surprise” given that there were fewer corporate insolvencies than in 2019 - before the coronavirus crisis hit the euro area. Nonetheless, he asked for caution as the central bank expects that “in 2021 we will see an important increase in terms of insolvencies.”

“Perhaps in this case, in this crisis, that is different to previous ones, the existence, and the implementation of support measures by fiscal authorities has increased, has lengthened (this lag),” he said on the time that it usually takes between the decline in growth and the evolution of corporate insolvencies.

Another risk on the ECB’s radar is the recent surge in US benchmark bond yields. This has already led the central bank to step up its government bond purchases in recent weeks, but the Frankfurt-based institution is still concerned that higher borrowing costs across the Atlantic will affect indebted corporates, households and nations in the euro area.

ECB President Christine Lagarde said at a press conference in March: “We are not doing yield curve control.”

However, the ECB is looking to avoid a premature rise in borrowing costs for euro area governments. This could derail the economic recovery in 2021, after the region’s gross domestic product contracted by almost 7% in 2020.

“If the increase in yields in unwarranted then, you know, we will act. If the increase in yields is the consequence of the normalization of the economy, then it is something that is going to be part of, let’s say, the broader framework,” de Guindos said.

In addition, the ECB also warned Wednesday that bank profitability in the euro area is still “weak” and lenders might be forced to step up their provisions going forward.

“Bank profitability remains weak, while prospects for lending demand are uncertain. Bank asset quality has been preserved so far, but credit risk may materialise with a lag, implying a need for increased loan loss provisions,” the ECB said in a statement.

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