Luis de Guindos: Financial stability in the euro area
Speech by Mr Luis de Guindos, Vice-President of the European Central Bank, at the
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Frankfurt Euro Finance Week, organised by the Euro Finance Group, Frankfurt am
Main, 18 November 2024.
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It is my great pleasure to continue the tradition of joining you at the Frankfurt Euro
Finance Week. In today's remarks I will provide you with our latest assessment of the
risks to financial stability in the euro area, which we will soon publish in more detail in
the ECB's Financial Stability Review - a publication that celebrates its twentieth
anniversary this week. I will then discuss the resilience of euro area banks and
nonbanks. And finally, with Europe at the crossroads, I will emphasise the importance of
strengthening financial integration, completing banking union and moving forward on
the capital markets union.
Volatile and uncertain macro-financial outlook
If you look at where we are now compared with a year ago, the balance of macro-risks
has shifted from concerns about high inflation to fears over economic growth.
Consumer price inflation has moved closer to our 2% target. But economic activity has
been weaker than expected: we have revised down our projections twice - before the
summer and in September. The growth outlook is clouded by uncertainty about
economic policies and the geopolitical landscape, both in the euro area and globally.
Trade tensions could rise further, increasing the risk of tail events materialising. These
cyclical headwinds compound structural issues of low productivity and weak potential
euro area growth.
Against a background of heightened uncertainty, our upcoming Financial Stability
Review highlights three main vulnerabilities that shape the euro area outlook.
Key financial stability vulnerabilities
The first vulnerability relates to financial markets, which remain susceptible to sudden,
sharp adjustments. While recent high-volatility episodes were short-lived and had only
limited impact on the financial system, underlying vulnerabilities make financial markets
prone to bouts of volatility in the future. First, record-low equity premia and compressed
corporate bond spreads are signs that investors may be underestimating the likelihood
and potential impact of adverse scenarios. Second, concentration of equity market
capitalisation and earnings among a handful of companies, notably in the United States,
has increased greatly in recent years, raising concerns over the possibility of an asset
price bubble connected to artificial intelligence. Given how deeply integrated global
equity markets are, negative firm-specific or sector-specific surprises could easily
spillover across the borders.
The second vulnerability relates to rising sovereign risks. While the aggregate euro area
debt-to-GDP ratio has declined considerably from its peak during the pandemic, debt
levels remain high in many countries owing to persistent primary deficits. Under these
circumstances, fiscal slippage or questions around fiscal consolidation paths could
trigger further repricing of sovereign risk. Current large primary deficits will also make it
harder for governments to support the economy if adverse shocks materialise, and they
will make it more difficult to provide additional investment to cope with structural
challenges, including climate change, defence spending, digitalisation and low
productivity. This in turn could give rise to a negative feedback loop between low growth
and sovereign debt sustainability.
The third vulnerability relates to credit risk. Amid weak growth prospects, credit risk
remains a concern for some euro area firms and households and could affect asset
quality of banks and non-banks. Overall, firms and households have weathered the
impact of past interest rate increases and appear resilient generally. Nevertheless high
- albeit declining - lending rates remain a challenge for some borrowers. Insolvencies -
a lagged indicator of corporate financial health - have been rising across sectors and
countries, although from relatively low levels. The debt servicing capacity of small and
medium-sized enterprises and of commercial real estate firms appears to be particularly
vulnerable to a slowdown in economic activity and higher borrowing costs. At the same
time, the euro area commercial real estate markets show signs of stabilisation, with
investor demand slowly recovering, in line with less restrictive monetary policy. In
addition, higher interest rates continue to challenge households with lower incomes and
floating-rate mortgages. Slower growth and a weakening labour market could further
undermine the debt servicing capacity of these borrowers.
Financial sector's resilience
The previous point in particular raises the question: are euro area financial institutions
well prepared to cope with these risks?
Here the good news is that bank balance sheets are strong, making it easier for banks
to absorb losses, if asset quality deterioration were to accelerate. Lower operating
expenses and strong net interest margins have enabled euro area banks to maintain
high levels of profitability. Banking sector resilience is bolstered by solid capital ratios
and liquidity buffers, despite the gradual phasing-out of funding from targeted
longerterm refinancing operations. That being said, bank profitability may have peaked, with
earnings on floating-rate assets becoming a headwind for interest income and credit
losses starting to rise.
Turning to the non-bank financial intermediation (NBFI) sector, non-banks remain
vulnerable to, and could amplify, macroeconomic and financial market shocks. A
significant proportion of non-banks' holdings - especially of corporate bonds and
equities - are from issuers in countries projected to experience low economic growth
and high levels of sovereign debt. Consequently, any potential downturn could weigh on
asset quality in NBFI portfolios. Additionally, the rising exposure of the NBFI sector to
global markets, including US-based technology firms, makes non-banks vulnerable to
shocks and volatility in those markets. This could expose the sector to sudden sharp
declines in asset values and returns, putting further strain on their resilience.
Some segments of the NBFI sector also face structural vulnerabilities related to liquidity
mismatches and high leverage. These issues make the sector more susceptible to
amplifying shocks through forced asset sales. When asset values or returns decline
sharply, open-ended investment funds - such as real estate funds - may be forced to
sell assets to meet redemption demands. This risk is heightened in sectors like
commercial real estate, as in some euro area countries a potential fall in property prices
has not yet been fully reflected in fund valuations. This implies that the risk of price
corrections and subsequent outflows remains elevated.
Furthermore, pockets of high financial and synthetic leverage in the investment fund
sector - most notably in hedge funds - introduces another layer of vulnerability. As we
have seen in previous crises, leverage can magnify losses, making the sector more
prone to systemic risks in times of market stress.
Safeguarding resilience and strengthening financial integration
Looking at the current highly uncertain geopolitical and economic environment,
regulatory standards remain key to preserve the resilience of banks and non-banks'
alike. Existing macroprudential capital buffer requirements for banks as well as
borrower-based measures should be maintained. In this context, it is reassuring that the
final elements of Basel III were implemented in EU law in June 2024.
While sound capital and liquidity buffers are the first line of defence against bank
failures, they must be complemented by steady and agile supervision in a full banking
union. Our work on this front is not yet done. To complete the banking union, we must
address key gaps in our institutional framework. This includes finalising the crisis
management toolkit for EU large banks and making progress in other areas, such as
liquidity in resolution and a backstop to the Single Resolution Fund. A critical gap that
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demands attention is the absence of a European deposit insurance scheme. Progress
towards a full banking union that would remove barriers to greater financial system
integration across euro area countries remains a priority if we want to make our banking
system more efficient.
It is also essential to strengthen the resilience of the NBFI sector, not only to protect
individual institutions but also to safeguard the broader stability of the financial system,
especially since a more resilient non-bank sector will reduce the likelihood of spillovers
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to the banking sector. A sound NBFI sector is also a prerequisite for achieving deeper
financial integration in the euro area and completing of the capital markets union.
Progress on the capital markets union should be central to a revised strategy to
enhance Europe's productivity and economic growth. Greater economic integration
goes hand-in-hand with greater financial integration. By mobilising capital markets more
effectively, we can deepen the Single Market and provide much-needed financing to
innovative and productive firms across Europe. This is crucial for supporting long-term
growth and securing the financing of the green transition.
However, achieving these objectives will not be without its challenges. The ambition to
strengthen capital markets must be accompanied by concrete policies. A more
prominent role for the non-bank financial sector should go along with a robust
macroprudential framework to ensure its resilience. The European Commission's
consultation on macroprudential policies for NBFI is an important step toward
addressing the risks in this industry.
Let me conclude with a clear message on the financial sector. Now is not the time to roll
back hard- won regulatory progress. With sources of risk and vulnerability remaining
elevated against a background of great uncertainty and weak growth prospects, our
current moment is one for upholding regulation, preserving resilience and pressing
ahead with macroprudential policies for non-banks. A stronger and stable financial
system with developed capital markets can be a vital engine of growth for Europe in the
years ahead.
1
See de Guindos, L., (2023), "Banking Union and Capital Markets Union: high time to
move on", speech at the Annual Joint Conference of the European Commission and the
European Central Bank on European Financial Integration, Brussels, 7 June.
2
See Franceschi, E. et. al., (2023), "Key linkages between banks and the non-bank
financial sector ", Financial Stability Review, ECB, May.