Financial stability review. November 2023.
Date: 2024-03-04
Institutions: European Central Bank
Subjects: economic recovery, euro area, financial institution, financial stability, monetary policy, serial publication, stability programme

Financial Stability Review 

November 2023 

 
 
 
 
 
 
Contents 

Foreword 

Overview 

1 

Macro-financial and credit environment 

1.1  A recession remains a possible scenario as an already weak 

economic outlook deteriorates 

1.2  Sovereign vulnerabilities remain elevated due to higher 

refinancing costs and a weak macro-financial outlook 

Box 1 Sovereign bond markets and financial stability: examining the 

risk to absorption capacity 

1.3 

Tight financial conditions are starting to weigh on the debt 
servicing capacity of non-financial corporations 

1.4  Households benefit from a strong labour market but face higher 

debt service costs 

1.5  Euro area residential and commercial real estate markets are 

experiencing a downturn 

2 

Financial markets 

2.1  Markets adjust to an environment of higher rates 

Box 2 The risks from hidden leverage in short-term equity options 

2.2 

Investors may be underestimating the risk of a slowdown in 
economic growth 

2.3  Rapid adoption of artificial intelligence might also have financial 

stability implications 

Box 3 Financial stability considerations arising from the digitalisation of 

financial services 

3 

Euro area banking sector 

3.1  Profitability at multi-year heights, but headwinds grow 

3.2  Early signs of asset quality deterioration from historical lows 

3.3  Rising funding costs as bonds reprice and deposit betas adjust 

Box 4 A digital euro: gauging the financial stability implications 

3.4 

Improved solvency and rising capital distributions 

Box 5 Euro area bank fundamentals, valuations and cost of equity 

Financial Stability Review, November 2023 – Contents 

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4 

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38 

41 

44 

48 

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55 

59 

62 

65 

68 

1 

 
 
4 

Non-bank financial sector 

4.1  Non-banks have proved resilient recently but may face 

challenges ahead as structural vulnerabilities persist 

4.2  Risks related to liquidity and leverage point to structural 

vulnerabilities in investment funds 

4.3 

Insurers remain resilient, but rising economic uncertainty could 
challenge profitability 

Box 6 Assessing liquidity vulnerabilities in open-ended bond funds: a 

fund-level redemption coverage ratio approach 

5 

Macroprudential policy issues 

5.1  Continue to preserve banking sector resilience to navigate the 

downturn 

5.2  Enhancing the policy framework for non-bank financial 

intermediation 

5.3  Other ongoing policy initiatives that support euro area financial 

stability 

Special features 

A 

B 

Assessing risks from euro area banks’ maturity transformation 

Real estate markets in an environment of high financing costs 

Acknowledgements 

71 

71 

74 

77 

81 

84 

84 

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93 

94 

94 

106 

117 

Financial Stability Review, November 2023 – Contents 

2 

 
 
Foreword 

The turbulence seen this last spring, triggered by bank failures outside the euro area, 
has now abated. While risks to financial stability may appear less acute, they remain 
elevated. Attention has shifted towards the impact of tight financial and credit 
conditions and weak economic prospects on the debt servicing capacity of 
borrowers, the ongoing correction in real estate markets and the resulting risks for 
banks and non-bank financial intermediaries. 

While tight financing conditions help align aggregate demand with supply and ensure 
that inflation returns to target, they can also push over-extended borrowers into 
financial distress. Steep increases in interest rates are particularly challenging for 
borrowers carrying high levels of debt contracted at variable rates or loans that fall 
due for refinancing in the near term. Disposable incomes, corporate revenues and 
fiscal positions may suffer an additional squeeze if economic activity disappoints 
further or if energy prices surge over the coming winter.   

Despite such risks, financial markets have remained resilient. This strength reflects 
expectations of a soft landing, with limited impacts on economic growth as inflation 
recedes to moderate levels. Sentiment could shift quickly if actual outturns were to 
deviate from this benign scenario, and disorderly adjustments could be amplified by 
non-bank financial institutions with elevated credit and liquidity risks. An escalation of 
the conflict in the Middle East could trigger a sharp increase in risk aversion in 
financial markets, unravelling the prevailing vulnerabilities. In addition to the potential 
adverse repercussions for the supply of energy commodities, an escalation could 
undermine general confidence and slow down economic growth, while pushing 
inflation rates up in parallel. 

Although their lending margins have until now largely benefited from rising interest 
rates, banks are beginning to face increasing headwinds. Demand for loans is 
cooling exceptionally quickly and loan losses are starting to rise, albeit from low 
levels. The ongoing correction in real estate markets – both commercial and 
residential – may compound these dynamics. 

This issue of the Financial Stability Review (FSR) includes two special features. The 
first examines different strategies employed by euro area banks to manage interest 
rate risk and the associated implications for bank profitability. The second looks at 
risks to euro area real estate markets in a turning property market cycle. 

The FSR has been prepared with the involvement of the ESCB Financial Stability 
Committee, which assists the decision-making bodies of the ECB in the fulﬁlment of 
their tasks. The FSR promotes awareness of systemic risks among policymakers, 
the ﬁnancial industry and the public at large, with the ultimate goal of promoting 
financial stability. 

Luis de Guindos 
Vice-President of the European Central Bank 

Financial Stability Review, November 2023 – Foreword 

3 

 
 
 
Overview 

Financial Stability Review, November 2023 – Overview 

4 

Euro area financial stability outlook remains fragileMarkets remain vulnerable to adverse dynamics which could be triggered by macro-financial surprises or geopolitical risks and amplified by high credit and liquidity risk in non-banks.Bank profitability has benefited so far from higher interest rates, but headwinds associated with deteriorating asset quality, lower lending volumes and higher funding costs lie ahead.Higher debt service costs are increasingly challenging indebted firms, households and sovereigns, with the real economy impact of tighter financial conditions yet to fully materialise.Markets are vulnerable to higher interest rates, slowing growth and geopolitical risks•Markets see high risk of elevated inflation •Refinancing risk rises for weaker borrowers•Slower growth may make risk premia widen•“AI rally” raises overvaluation concernsHeadwinds to bank profitability as asset quality concerns and funding costs riseRising credit risk could add to liquidity and leverage concerns in non-banks•Further uptick in payment arrears possible•Sharp decline in lending growth•Rising cost of deposit funding •Persistent gap between COE and ROE•Rising credit risk in portfolios•Liquidity and leverage risks in funds persist•Exposures to declining real estate valuations•Insurers could face profitability challenges2000202315.4%18.3%Weak economic outlook threatens debt servicing capacity of the non-financial sector•Sovereign debt sustainability concerns resurface•Higher funding costs could spur corporate defaults•A turning labour market could hamper debt servicing•Real estate correction may turn disorderly3.201/2311/23481216202024E2023EOn the back of active prudential policy in recent years, the euro area banking system is resilient and well-placed to face higher risks.Targeted macroprudential policy action, regulatory reform and faithful implementation of Basel III can help to ensure durable resilience.Structural vulnerabilities in non-banks continueto require a comprehensive and decisive policy response.Non-financial sector debt service ratioLong-term EUR forward ratesROE projectionsFunds' syntheticleverage352024LowMediumHighLiquidityNotional / margin 
 
 
 
 
 
Euro area financial stability outlook remains fragile 

Financial stability risks associated with higher interest rates are emerging in 
the context of a challenging macro-financial outlook and geopolitical tensions. 
Financial markets quickly shook off the shock triggered by the bank failures in the 
United States and Switzerland in March this year and the related expectations of an 
earlier end to the monetary tightening cycle. Since then, financial stability concerns 
have pivoted towards the implications of upside risks to inflation and downside risks 
to growth. Rising ECB policy rates have translated into rising funding costs for all 
sectors of the economy (Chart 1, panel a). The associated tighter financial and credit 
conditions are being transmitted to economic activity (Chart 1, panel b). This holds 
particularly true for the euro area where – unlike the United States – economic 
outcomes have surprised on the downside since the summer. However, as duration 
lengthened in the financial system and the real economy during the low interest rate 
era, a major part of the impact of monetary tightening is yet to materialise, which will 
pose future challenges for financial and non-financial sectors alike. These concerns 
are amplified by the recent flare-up of geopolitical tensions in the Middle East. They 
add to the uncertainty surrounding the macro-financial outlook (Chart 1, panel c), not 
only because of possible adverse repercussions for energy commodities supply, 
should the conflict escalate further, but also given their potential to spark risk 
aversion in financial markets and undermine confidence in the real economy. 

Chart 1 
Euro area financial stability outlook remains fragile as tighter financing conditions are 
increasingly propagating to the real economy and geopolitical tensions intensify 

a) Composite funding costs, 
by economic sector 

b) Financial conditions index 
and manufacturing PMIs 

c) Geopolitical risk index and 
oil price volatility 

(Jan. 2011-Sep. 2023, percentages) 

(July 2020-Oct. 2023; diffusion index, 
percentages) 

(1 Jan. 2015-14 Nov. 2023; index, 
percentages, 7-day moving averages) 

Sources: Caldara and Iacoviello*, Bloomberg Finance L.P., S&P Global Market Intelligence, ECB (MIR, PDF) and ECB calculations. 
Note: Panel a: Non-financial corporations: weighted average of the costs of bank borrowing, market-based debt and equity, based on 
the respective amounts outstanding. Sovereigns: ten-year government benchmark bond yield. Households: lending rates for new 
loans for house purchase, consumer credit and other household loans weighted by their respective outstanding credit amounts. 
Banks: volume weighted average of the cost for banks of collecting deposits and the cost for banks of issuing bonds, weighted by the 
respective outstanding amounts. . Panel b: Goldman Sachs’ financial conditions index (FCI) is a weighted average of risk-free interest 
rates, exchange rates, equity valuations and credit spreads, with weights corresponding to the direct impact of each variable on GDP. 
*) Caldara, D. and Iacoviello, M., “Measuring Geopolitical Risk”, American Economic Review, Vol. 112, No 4, April 2022, pp. 1194-
1225. 

Financial Stability Review, November 2023 – Overview 

5 

-10123456720112014201720202023ECB deposit facilityrateNon-financialcorporationsSovereignsHouseholdsBanks404550556065-505Purchasing Managers’ Index Tighter conditionsLooser conditionsWeaker growthStronger growthYear-on-yearchange in FCIEuro areaUnitedStatesCurrent (October 2023)0.00.20.40.60.81.01.21.41.61.805010015020025030035040045020152017201920212023Geopolitical risk indexOil price volatility (right-hand scale) 
 
 
 
 
Against this backdrop, three key themes shape the outlook for euro area 
financial stability. First, markets and non-banks remain highly vulnerable to 
adverse macro-financial and geopolitical surprises and associated shifts in market 
sentiment. Second, tighter financial and credit conditions are increasingly translating 
into higher debt service costs, weakening the resilience of firms, households and 
sovereigns. Third, growing vulnerabilities in the real economy can be expected to 
gradually impair banks’ asset quality, and this, together with lower lending volumes 
and rising funding costs, may challenge their profitability outlook. 

Financial markets and non-banks are vulnerable to 
adverse macro-financial surprises 

The pricing in financial markets appears to be predicated on optimistic 
expectations regarding the future macro-financial outlook and hence remains 
vulnerable to negative surprises. Up until August, expectations that the monetary 
tightening cycle was nearing its end, with a soft-landing scenario for economic 
growth and inflation, served to lower market volatility and support investor sentiment 
(Section 2.1). Global equity markets performed particularly strongly after the turmoil 
triggered by stresses in the US and Swiss banking sectors in March (Chart 2, panel 
a) – albeit driven to a large extent by a US tech industry that has benefited from 
enthusiasm regarding the opportunities offered by artificial intelligence (Section 2.3). 
In the euro area equity market, volatility has been out of sync with the current weak 
phase of the economic cycle (Chart 2, panel b). At the same time, corporate credit 
spreads have remained relatively compressed, while liquidity conditions in sovereign 
and corporate bond markets have improved. In September, the transition of financial 
markets towards expectations of higher-for-longer rates gained momentum and was 
accompanied by rising term premia. This led to a rapid increase in long-term 
government bond yields and higher equity market volatility, which started to weigh on 
riskier asset valuations as well. However, the market correction proved to be short-
lived, as investor confidence benefited again from a downside surprise in inflation. 

Risk sentiment in the markets remains fragile and highly sensitive to further 
surprises regarding the outlook for inflation, growth and, by extension, the 
path of monetary policy. If inflation were to prove more persistent than currently 
anticipated, this could lead to a further increase in long-term interest rates. Coupled 
with weaker than anticipated economic growth, this, in turn, could trigger a rise in 
market volatility and risk premia, increasing the likelihood of credit events 
materialising. Adverse market dynamics could be triggered by unexpected 
geopolitical shocks and amplified by vulnerabilities associated with the increased 
digitalisation of financial services (Box 3), heightened leverage in equity option 
markets (Box 2) and possible forced asset sales by non-bank financial institutions. 

Financial Stability Review, November 2023 – Overview 

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Chart 2 
Investor optimism leaves markets vulnerable to disorderly repricing, especially if 
volatility jumps and funds with low liquidity buffers are forced to sell assets 

a) Global equity and bond 
market prices 

b) Distribution of VSTOXX, by 
PMI signal 

(1 Jan. 2022-14 Nov. 2023, indices) 

(2 Jan. 2012-14 Nov. 2023, index) 

c) Distribution of funds’ HQLA 
stock and historically high 
outflows 

(Q2 2023 (HQLA), Jan. 2007-June 2023 
(outflows), percentages of total net assets) 

Sources: Bloomberg Finance L.P., S&P Global Market Intelligence, LSEG Lipper IM, ECB (CSDB) and ECB calculations. 
Notes: Panel a: global equity markets are reflected by the MSCI All Country World Index and global bond markets by the Bloomberg 
Barclays Multiverse Index. Panel b: based on Composite PMI with readings above 50 indicating growth. The whiskers correspond to 
the minimum and maximum values observed. Panel c: the box plots show the distribution of fund-level stocks of high-quality liquidity 
assets (HQLA), calculated according to the Basel Liquidity Coverage Ratio Requirements for HQLA. Whiskers refer to the 5th and 95th 
percentiles of the distribution respectively. HQLA Level 1 assets include cash, cash equivalents and qualifying government bonds, 
while Level 2A and Level 2B assets include less liquid assets such as qualifying covered bonds, corporate bonds, asset-backed 
securities and equities. The stock of HQLA is calculated by applying a haircut of 0% to cash and Level 1 assets, 15% to Level 2A 
assets and 40% to Level 2B assets. The red dots show the worst outflows for each fund category – calibrated in line with ESMA’s 
stress simulation for investment funds* – as the 5% expected shortfall, which averages monthly fund-level net flows experienced 
between January 2007 and June 2023 by a sample of bond and equity funds below the 5th percentile of the distribution. AE stands for 
advanced economies; EME stands for emerging market economies; HY stands for high yield; IG stands for investment grade. 
*) See ESMA, “Stress simulation for investment funds”, ESMA Investment Report, 2019. 

Non-banks continue to face high credit risks, despite some rebalancing of 
their investment portfolios towards safer assets. As of mid-2023 cumulative 
purchases of investment-grade sovereign and corporate debt by the non-bank 
financial intermediation (NBFI) sector over one year have been close to the record 
highs observed during the post-pandemic recovery (Section 4.1). Shifts by investors 
towards safer fund types helped mitigate aggregate credit risk in the sector thanks to 
reduced incentives to search for yield. That said, high economic uncertainty and 
tighter financial conditions have contributed to a deteriorating credit outlook for 
several issuers, exposing the NBFI sector to possible revaluation losses stemming 
from downgrades and an increase in default risk. In particular, some non-banks 
remain heavily exposed to interest rate-sensitive sectors, such as highly indebted 
corporates and real estate. Deteriorating corporate fundamentals and the ongoing 
correction in real estate markets could expose non-banks investing in these sectors 
to revaluation losses and investor outflows. 

Low liquid asset holdings could expose investment funds to the potential risk 
of forced asset sales if macro-financial outcomes deteriorate. Overall liquidity 
buffers remain relatively low across the investment fund sector (Section 4.2), 
although aggregate figures mask large differences across and within fund types. This 

Financial Stability Review, November 2023 – Overview 

7 

19020021022023024025054058062066070074078001/2207/2201/2307/23GlobalequitymarketGlobal bondmarket (right-hand scale)0102030405060708090PMI –growthPMI –contraction VSTOXXinterquartile rangeVSTOXX -current020406080100120140AE sovereignEMEHY corp.IG corp.Mixed corp.EquityHQLA interquartile rangeHistoricallyhighoutflowsHQLA median 
 
 
 
 
suggests that there is a more vulnerable cohort of funds with inadequate liquidity 
buffers to meet a redemption shock equivalent in size to the worst recorded outflows 
(Chart 2, panel c). As such, the risk remains high that, in the event of sudden 
liquidity needs, some funds could amplify adverse market dynamics by exhibiting 
procyclical selling behaviour. Granular fund-level data on open-ended bond funds 
suggest that their liquidity resilience to severe redemptions has deteriorated 
compared with levels observed before the pandemic (Box 6). This could introduce 
risks to wider financial stability, especially when low liquidity buffers coincide with 
relatively high leverage (Section 4.2). All in all, this highlights the importance of 
strengthening the resilience of the NBFI sector from a macroprudential perspective 
(Chapter 5). 

Tighter financial conditions are testing the resilience of 
euro area firms, households and sovereigns 

Euro area corporate profitability has held up well, but higher interest rates are 
weighing on the debt servicing capacity of more vulnerable firms. High profit 
margins have continued to underpin corporate profitability, but activity has been 
slowing in several sectors (Section 1.3). Tighter financing conditions, in terms of 
both the cost and the availability of credit, coupled with the uncertain business 
outlook, have led to a material drop in firms’ external financing (Chart 3, panel a). As 
the stock of loans continues to reprice, higher debt service costs could challenge 
cyclical sectors more than defensive sectors. The redemption profiles show that 
cyclical sectors are generally more exposed to refinancing risk, as a larger share of 
their bonds matures in the short term (Chart 3, panel b). Rollover risk might be 
further accentuated if the economy were to weaken at the same time. Weaker 
macro-financial conditions have already started to translate into higher corporate 
insolvencies: in aggregate, these have now surpassed pre-pandemic levels, albeit 
unevenly across sectors. While this partly reflects the unwinding of the insolvency 
backlog that accumulated during the pandemic, defaults are likely to rise even more 
if yields continue increasing or if energy prices start soaring again, for example. This 
is already reflected in rising expected default frequencies, in particular for the more 
vulnerable high-yield segment (Chart 3, panel c). Looking ahead, a sharper 
economic slowdown than currently anticipated could prove challenging for euro area 
firms, especially if they have high debt levels, subdued earnings and low interest 
coverage ratios. 

Financial Stability Review, November 2023 – Overview 

8 

 
 
Chart 3 
Tighter financial conditions are increasingly challenging the debt servicing capacity of 
firms, given high short-term debt servicing needs and rising corporate insolvencies 

a) Financing flows of non-
financial corporations, by 
funding instrument 

b) Maturity wall for euro area 
non-financial firms, by type of 
industry 

c) Corporate EDFs in the euro 
area, by rating category   

(Q1 2020-Q3 2023, € billions) 

(2024-30, percentages) 

(1 Jan. 2014-14 Nov. 2023, percentages) 

Sources: Bloomberg Finance L.P., Moody's Analytics, Intercontinental Exchange, ECB (BSI, CSEC) and ECB calculations. 
Notes: Panel b: figures include corporate bonds that are not in default and are issued by euro area entities. Cyclical sectors include 
consumer discretionary, technologies, energy, materials, industrials and communications. Defensive sectors include consumer staples, 
health care and utilities. Panel c: EDFs stands for the expected default frequencies of non-financial corporations. 

Real estate firms are particularly vulnerable to losses in the light of the 
ongoing downturn in euro area commercial real estate markets. In an 
environment of tighter financing conditions and elevated macro-financial uncertainty, 
commercial real estate (CRE) prices have continued to decline (Chart 4, panel a), 
with subdued market activity hampering price discovery. The effects of higher 
interest rates have been compounded by structurally lower demand for some CRE 
assets following the pandemic. In fact, demand for office space deteriorated sharply 
in the second quarter of 2023, particularly in the non-prime segment where concerns 
about the environmental footprint of buildings play a more important role. This mix of 
cyclical and structural challenges has resulted in real estate firms suffering 
significant rating downgrades in recent months (Section 1.5). Conditions have been 
particularly challenging for property developers faced with falling sales prices, 
contracting order books and rising input costs. As such, the stock prices of real 
estate firms have continued to underperform the overall market by a large margin 
(Chart 4, panel b). From a systemic risk perspective, adverse CRE market outcomes 
on their own are unlikely to cause losses that would take the euro area banking 
sector below minimum capital requirements, but a significant deterioration in CRE 
asset quality could pose challenges for some banks that are more heavily exposed 
to CRE loans (Special Feature B). 

Euro area households, especially those with lower incomes and in countries 
with mainly floating-rate lending, are increasingly being challenged by higher 
interest rates. Resilient labour markets as well as government support measures 
and excess savings accumulated during the pandemic have so far mitigated euro 

Financial Stability Review, November 2023 – Overview 

9 

-200-10001002003004005006002020202120222023ThousandsNetflow of bankloansNet debt issuanceNet equity issuanceTotal0246810121416Cyclical sectorsDefensive sectors20242025202620272028202920300.00.20.40.60.81.01.21.41.61.82.020142016201820202022A/AABBBB/BB 
 
 
 
 
area household vulnerabilities. However, real household incomes and consumption 
remain under pressure, especially in the lower income segments. At the same time, 
higher interest rates have begun to feed through to higher debt service costs, notably 
in countries where the share of variable-rate lending has historically been very high 
(Section 1.4). Going forward, households may see their debt servicing capacity 
erode if energy prices soar again, interest rates remain higher for longer and/or 
labour market conditions deteriorate significantly. 

Chart 4 
Residential and commercial real estate markets have continued their simultaneous 
downturn, as higher funding costs weigh on affordability 

a) Euro area real GDP growth, 
and RRE and CRE prices 

b) Stock prices of real estate 
firms versus the overall 
market 

c) Real estate price index and 
cost of household mortgage 
borrowing in the euro area 

(Q1 2006-Q2 2023, annual percentage 
changes) 

(4 Jan. 2008-10 Nov. 2023, indices: 
Jan. 2008 = 100) 

(Q1 2015-Q2 2023, percentages, index) 

Sources: Bloomberg Finance L.P., Eurostat and ECB (MNA), ECB (MIR, RESC) and ECB calculations. 
Note: Panel b: real estate firms are represented by the STOXX Europe 600 Real Estate Price and the overall market by the STOXX 
Europe 600. 

The ongoing correction in residential real estate (RRE) markets may 
compound pre-existing vulnerabilities of euro area households. Euro area RRE 
markets continued to cool in the first half of 2023 (Chart 4, panel a), with prices 
already starting to fall in a number of countries. The steep increase in borrowing 
costs, coupled with deteriorating consumer confidence and housing market 
prospects, has had a negative impact on the demand for mortgages. This, together 
with a substantial tightening of credit standards by banks, led to a sharp drop in new 
lending (Section 1.5). On the supply side, challenging housing market conditions are 
reflected in weak construction confidence and a sharp drop in the issuance of new 
residential building permits. Despite declining prices in some euro area countries, 
valuations still seem stretched, suggesting that further falls are possible. In 
particular, RRE markets could come under severe stress should a material 
weakening of the labour market add to the affordability challenges arising from 
tighter conditions in mortgage markets (Chart 4, panel c, Special Feature B). 

Medium-term sovereign vulnerabilities are rising, particularly for jurisdictions 
where debt levels are already high. With maturing public debt being rolled over at 

Financial Stability Review, November 2023 – Overview 

10 

-6-4-20246-12-8-40481220062010201420182022GDP(right-handscale)RREpricesCREprices-14.2%14.5%20406080100120140160200820112014201720202023RealestatefirmsOverallmarketQ1 2015951051151251351451551234Nominal real estate price indexQ2 2023Cost of household mortgage borrowing 
 
 
 
 
higher interest rates, sovereign interest payments have started to rise, mainly in 
countries where short-term refinancing needs are higher. Sovereign issuance activity 
in primary markets has remained brisk this year (Chart 5, panel a). Increased 
issuance by euro area sovereigns has been smoothly absorbed by the market 
despite reduced Eurosystem asset purchases as a result of quantitative tightening. 
Demand might have been supported by the higher yields offered by sovereign bonds 
(Box 1). Nevertheless, fiscal fundamentals remain fragile in a number of countries in 
the light of weaker economic growth prospects, given elevated debt levels and 
continued high budget deficits (Chart 5, panel b). So far, spreads in the government 
bond market have remained contained, as many sovereigns managed to secure 
cheap financing at longer maturities during the period of low interest rates. However, 
risks of fiscal slippage could reignite sovereign debt sustainability concerns and 
compel market participants to reassess sovereign risk. Any unwarranted, disorderly 
sovereign debt market dynamics that may pose a serious threat to the transmission 
of monetary policy across the euro area can be countered by the ECB’s 
Transmission Protection Instrument if the necessary conditions are fulfilled. 

Chart 5 
Short-term sovereign stress has remained contained so far, but higher funding costs 
and less prudent fiscal policies could reignite sovereign debt sustainability concerns 

a) Net issuance of government debt securities 
in the euro area 

b) General government debt, budget balance 
and rating outlooks across the euro area 

(Jan. 2019-Sep. 2023, € billions) 

(average values over 2023-24, percentages of GDP) 

Sources: ECB (GFS), Moody’s Analytics, Fitch Ratings, S&P Global Market Intelligence, European Commission (AMECO) and ECB 
calculations. 
Notes: Panel b: rating outlook refers to the average from Moody’s Analytics, Standard & Poor’s and Fitch and represents the outlook 
as at 14 November 2023. The vertical red line represents the Maastricht government deficit criterion of 3% of GDP. The horizontal red 
line represents the threshold of 90% of GDP for sovereign debt and is based on findings in the empirical literature. See, for example, 
Checherita, C. and Rother, P., “The impact of high and growing government debt on economic growth – an empirical investigation for 
the euro area”, Working Paper Series, No 1237, ECB, 2010. 

Financial Stability Review, November 2023 – Overview 

11 

02004006008001,0001,200Jan.Feb.Mar.Apr.MayJuneJulyAug.Sep.Oct.Nov.Dec.Thousands20192020202120222023ATBECYDEESEEFIFRGRIEITLULTLVMTNLPTSKSIHREA0306090120150180-7-6-5-4-3-2-10123General government debt General government budget balancePositive outlookStable outlookNegative outlook 
 
 
 
Higher rates underpin bank profitability, but worsening 
asset quality and higher funding costs pose headwinds 

Euro area banks’ profitability has continued to improve on the back of rising 
interest rates, but uncertainties around the earnings outlook have increased. 
Boosted mainly by wider interest margins, euro area banks continued to enjoy robust 
earnings growth in the first half of 2023. They posted the highest profitability levels 
witnessed in more than a decade, with an almost double-digit return on equity (Chart 
6, panel a). The strengthening of profitability was particularly notable for banks in 
countries where variable-rate lending predominates and where the pass-through of 
higher policy rates to deposit costs has been slower (Chapter 3). Going forward, 
though, banks will increasingly feel the downside impact of higher interest rates, as 
tighter financing conditions and a higher cost of living adversely affect borrowers’ 
debt servicing capacity. While banks’ non-performing loan ratios remained broadly 
unchanged at a low level of just above 2% in the first half of 2023, there have been 
some nascent signs of rising losses on some loan portfolios that are more sensitive 
to cyclical downturns. In fact, default rates on both corporate and retail exposures 
have already started picking up (Chart 6, panel b), heralding further increases in 
non-performing loans. As such, banks may face the risk of higher provisioning costs 
as risks in the non-financial sectors materialise in the context of weaker than 
anticipated economic conditions, potentially higher-for-longer interest rates or 
possible disorderly developments in real estate markets. 

In addition, lower lending volumes and higher bank funding costs may weigh 
on euro area bank earnings going forward. Lending dynamics have slowed 
markedly as a result of tighter lending standards and weak credit demand, with year-
to-date lending flows to households and firms reaching their lowest levels since 
2015. Uncertain macro-financial conditions may continue to weigh on volume growth 
going forward, partly offsetting the positive margin effect of higher interest rates on 
banks’ net interest income. After the stress in the US and Swiss banking markets in 
the spring of this year, bank bond spreads stabilised at levels above historical 
averages. At the same time, the gradual shift from overnight to term deposits 
continued, with some signs of increased deposit competition among banks, but the 
pace of deposit repricing remains limited compared with previous hiking cycles. 
Looking ahead, bank funding costs are set to rise further as maturing liabilities 
reprice at higher levels (Chart 6, panel c), targeted longer-term refinancing operation 
(TLTRO) funds are gradually repaid and the composition of funding moves back 
towards long-run averages with a higher share of term deposits and bonds (Chapter 
3). In terms of the management of interest rate risk, euro area banks have made 
increasing use of the interest rate swaps market since 2021, especially for longer 
maturities (Special Feature A). 

The resilience of the euro area banking sector is, in aggregate, underpinned by 
strong capital and liquidity positions. Euro area banks proved resilient to the 
bouts of stress in the US and Swiss banking markets earlier this year, building on 
solid bank fundamentals. Standard regulatory metrics point towards strong liquidity 
resilience overall, despite a recent decline in banks’ liquidity coverage ratios 
following TLTRO repayments. At the same time, with payout ratios increasing only 

Financial Stability Review, November 2023 – Overview 

12 

 
 
slightly, capital ratios have risen in line with higher retained earnings. The euro area 
banking sector’s resilience to adverse shocks was also confirmed by the results of 
the European Banking Authority’s 2023 EU-wide stress test. To preserve resilience 
from a more structural perspective, euro area banks need to carefully manage the 
implications of climate change and should also address the risks posed by the 
digitalisation of the financial industry. Such risks include the accelerated pace of 
bank runs (Box 3), the growing threat from cyber risks and the challenges 
associated with the introduction of digital currencies (Box 4). 

Chart 6 
Rising rates helped bank profitability improve, but the prospect of deteriorating asset 
quality and higher funding costs increases downside risks to bank earnings 

a) Euro area banks’ return on 
equity, cost of equity and 
price-to-book ratios 

b) Default rates on banks’ 
corporate and retail 
exposures 

c) New and existing rates on 
bank deposits and bonds 

(Q1 2015-Q2 2023, percentages, ratios) 

(Q1 2018-Q2 2023, percentages) 

(Sep. 2023, percentages) 

Sources: Bloomberg Finance L.P., Dealogic, ECB (supervisory data, MIR) and ECB calculations. 
Notes: Panel a: the dashed horizontal lines represent the long-term averages, i.e. Q4 2000-Q2 2023, for banks’ return on equity, cost 
of equity and price-to-book ratio. Banks’ estimated cost of equity is calculated following the methodology set out by Altavilla et al.* 
Panel b: annualised quarterly default rates (two-quarter moving averages). Panel c: for all funding sources except bonds, existing rates 
indicate the average annual rate paid over the last 12 months and the latest monthly observation so as to account for the timing of the 
recognition of higher expenses in profit and loss. For bonds, “New rates” refers to the weighted average yield at issuance on new 
issuances within the latest month and “Existing rates” to the weighted average yield at issuance for all outstanding bonds. MFIs/OFIs 
stands for monetary financial institutions/other financial institutions. 
*) Altavilla, C., Bochmann, P., De Ryck, J., Dumitru, A., Grodzicki, M., Kick, H., Melo Fernandes, C., Mosthaf, J., O’Donnell, C. and 
Palligkinis, S., “Measuring the cost of equity of euro area banks”, Occasional Paper Series, No 254, ECB, 2021. 

Despite greatly improved profitability and continued resilience across the 
sector, bank valuations have remained compressed. Among other things, this 
may be explained by the lingering structural problems across the industry (such as 
low cost-efficiency) and the high risk premia embedded in banks’ cost of equity (Box 
5). Low valuations may also reflect concerns about the sustainability of bank profits, 
given one-off factors such as the imposition of bank levies – or discussions in that 
direction – in a number of countries, as well as the headwinds associated with the 
prospect of worsening asset quality and higher funding costs going forward. 

Financial Stability Review, November 2023 – Overview 

13 

0.00.51.01.52.02.5-10-505101520152017201920212023Return on equityEstimated cost of equityPrice-to-book ratio (right-hand scale)0.00.51.01.52.02.5201820192020202120222023Corporate exposuresRetail exposures0.00.51.01.52.02.53.03.54.04.55.0OvernightRedeemableTermMFIs / OFIsBondsNew ratesExisting rates 
 
 
 
 
Macroprudential policies should help safeguard and 
strengthen resilience across the financial system 

Safeguarding banking sector resilience remains key to navigating the turn of 
the financial cycle. Euro area macroprudential authorities have increased capital 
buffer requirements further in recent months, thereby bolstering banks’ resilience. 
These actions have also strengthened the macroprudential policy space by 
expanding potentially releasable capital buffers. Macroprudential authorities should 
preserve these buffers to ensure that they remain available in case conditions in the 
banking sector deteriorate. They should also ensure that borrower-based measures 
remain in place as structural backstops to prevent lending standards deteriorating 
and to protect borrower quality. Beyond highlighting the importance of resilient 
banking systems, the lessons learnt from the stress in the US and Swiss banking 
markets in the spring of this year reaffirm the need to implement outstanding Basel 
III reforms and complete the banking union. Against this backdrop, recent initiatives 
to impose taxes on banks may have negative repercussions for financial stability, as 
they make it harder for banks to accumulate capital. 

Structural vulnerabilities in different parts of the non-bank financial sector 
require a comprehensive policy response to increase resilience. Parts of the 
non-bank financial sector remain sensitive to adverse developments in macro-
financial conditions that could place downward pressure on asset valuations, 
particularly in the case of riskier assets. Structural vulnerabilities arising from liquidity 
mismatches and leverage could amplify market-wide price corrections and aggravate 
liquidity stresses in the financial system. The large market footprint and 
interconnectedness of non-bank financial institutions make it all the more important 
to increase the sector’s resilience by developing a comprehensive set of policy 
measures across non-bank entities and activities, taking a macroprudential 
perspective. This includes enhancing the liquidity preparedness of non-bank market 
participants to meet margin and collateral calls, tackling risks from non-bank 
leverage and mitigating liquidity mismatch in open-ended funds. International policy 
coordination will be key in this context to promote a level playing field and minimise 
the risk of cross-border arbitrage. 

Financial Stability Review, November 2023 – Overview 

14 

 
 
1 

Macro-financial and credit environment 

1.1 

A recession remains a possible scenario as an already 
weak economic outlook deteriorates 

Several downward revisions to forecasts and negative economic surprises 
confirm a weak economic outlook with substantial downside risks. The 
ECB/Eurosystem staff macroeconomic projections as well as other official and 
private sector forecasts were revised downwards for several quarters in a row, 
reflecting a worsened global economic environment, tighter financial conditions, 
lower aggregate demand and lower credit supply. Weak foreign demand and 

Financial Stability Review, November 2023 – Macro-financial and credit environment 

15 

Higher funding costs could lead to corporate defaultsSovereign debt sustainability concerns resurfaceReal estate correction may turn disorderlyA turning labour market could hamper debt servicingEmployment growth• Sovereign debt sustainability concerns resurface•Higher funding costs could lead to corporate defaults•A turning labour market could hamper debt servicing•Real estate correction may turn disorderlyWeak economic outlook threatens debt servicing capacity of the non-financial sectorStandard deviation of RRE and CRE demandGeneral government budget balanceInterest coverage ratio20082023CRE demandRRE demand-0.03-0.8912/1903/2310.110.41220192025E-7.2%-2.9%Q3 2020Q2 20231.60%20002023Non-financial sectordebt service ratio15.4%18.3%Higher funding costs could spur corporate defaultsSovereign debt sustainability concerns resurfaceReal estate correction may turn disorderlyA turning labour market could hamper debt servicingEmployment growth• Sovereign debt sustainability concerns resurface•Higher funding costs could spur corporate defaults•A turning labour market could hamper debt servicing•Real estate correction may turn disorderlyWeak economic outlook threatens debt servicing capacity of the non-financial sectorStandard deviation of real estate demandEuro area 10-year government bond yieldsFirms’ interest coverage ratio20002023Non-financial sectordebt service ratio15.4%18.3%Q4 19Q2 2310.1%9.3%12%20082023CommercialResidential-0.03-0.8901/2010/233.7%0.3%Q3 20Q2 231.5%0.1% 
 
 
receding fiscal support are weighing on activity, too. As of the third quarter of 2023, 
GDP growth is expected to come in at 0.7% in 2023 and 1.0% in 2024, the latter 
being a reduction of 60 basis points compared with six months earlier (Chart 1.1, 
panel a). While economic surprises have been to the upside in the United States in 
2023, the news has been predominantly more negative than expected for the euro 
area and China (Chart 1.1, panel b). Even though forecasts indicate that the euro 
area economy might enjoy a soft landing, a recession also remains a likely scenario 
(see also Chapter 2). This risk is captured by the manufacturing Purchasing 
Managers’ Index (PMI) – historically a reliable predictor of GDP growth – being in 
clearly contractionary territory (below 50 index points) as of the third quarter of 2023 
(Chart 1.1, panel c). In addition, the one-year ahead GDP growth-at-risk estimate 
indicates that, with a probability of 5%, economic growth within the next 12 months 
may turn out lower than -1.6%, which would mean a more severe contraction. This 
suggests that there are downward risks to overall economic activity in the euro area, 
albeit varying from country to country. 

Chart 1.1 
Several rounds of downward revisions to forecasts confirm a weak economic outlook 

a) ECB forecasts for annual 
euro area GDP growth 

b) Citi Economic Surprise 
Index 

c) GDP growth-at-risk and 
euro area manufacturing PMI 

(2023-25, percentages) 

(3 Jan. 2022-14 Nov. 2023, index) 

(Q1 2000-Q3 2023, left-hand scale: 
percentages, right-hand scale: index) 

Sources: ECB/Eurosystem staff macroeconomic projections, Bloomberg Finance L.P., Citigroup, S&P Global Market Intelligence, ECB 
and ECB calculations. 
Notes: Panel a: includes GDP growth for Q1 and Q2 2023 as already reported at the time of publication. The respective forecasts are 
for the entirety of 2023 as per the respective ECB/Eurosystem staff macroeconomic projection rounds of Q1 through Q3 2023. Panel 
b: Citi Economic Surprise Index values above zero represent positive economic surprises in sum, while values below zero represent 
negative economic surprises. Panel c: growth-at-risk is the 5th percentile prediction of a quantile regression model estimated on a 
panel of euro area countries. Explanatory variables include GDP growth and indicators of cyclical systemic risk, financial stress, the 
debt service ratio and economic sentiment. See Lang, J.H., Rusnák, M. and Greiwe, M., “Medium-term growth-at-risk in the euro 
area”, Working Paper Series, No 2808, ECB, 2023. 

The risk of higher energy prices interrupting the ongoing decline of headline 
inflation cannot be ruled out. Headline inflation in the euro area declined notably 
from over 10% year on year in October 2022 to 2.9% in October 2023. The 
dispersion of inflation across countries also narrowed markedly. However, core 
inflation remains persistently high and only started to decline in September 2023 
(Chart 1.2, panel a). The majority of professional forecasters see annual headline 
inflation declining to below 3.4% in 2024 and below 2.4% in 2025 (Chart 1.2, panel 

Financial Stability Review, November 2023 – Macro-financial and credit environment 

16 

0.00.20.40.60.81.01.21.41.61.8202320242025Q1 2023Q2 2023Q3 2023-200-150-100-5005010015020001/2204/2207/2210/2201/2304/2307/2310/23Euro areaUnited StatesChina010203040506070-12-10-8-6-4-2024200020042008201220162020One-year ahead growth-at-riskManufacturing PMI (right-hand scale) 
 
 
 
 
b).1  Whether rising energy prices, especially for liquified natural gas, will affect 
inflation over the winter will largely depend on weather conditions, as well as on 
global economic and political developments. An interruption of liquified natural gas 
supplies from Russia or higher than expected demand from China could result in 
substantially higher prices, as energy price volatility remains elevated (Chapter 2). 
That said, the EU is entering the colder season well prepared, with natural gas 
storage facilities almost full (Chart 1.2, panel c). A continuation of the recent rise in 
oil prices or more notable increases due to a possible further escalation of the 
conflict in the Middle East may add to inflationary pressures as well as to downside 
risks to economic growth (Overview). 

Chart 1.2   
The decline in inflation could be challenged by rising energy prices in the event of a 
harsh winter or shifts in global economic and geopolitical risks 

a) Euro area inflation 

b) Headline inflation forecasts  c) EU natural gas storage 

levels 

(Dec. 2020-Oct. 2023, percentages) 

(2023-25 as at Q3 2023, distribution, 
percentages) 

(2010-23, total share, percentages) 

Sources: ECB, ECB Survey of Professional Forecasters and Bloomberg Finance L.P. 
Notes: Panel a: the latest inflation data refer to October 2023. Panel b: the forecast distribution is as at Q3 2023. Panel c: the latest 
natural gas storage data are as at 14 November 2023. 

Euro area growth prospects may be adversely affected by a further slowdown 
of the Chinese economy and geopolitical tensions. The ongoing crisis in the 
Chinese real estate sector is weighing on economic activity in China, resulting in 
lower demand for European export goods, with a negative knock-on effect on euro 
area growth. Even though direct euro area bank exposures to the Chinese real 
estate sector are limited, other transmission channels may allow for spillovers, 
should the situation deteriorate further (Chapter 2). Generally, there might be a 
further aggravation of geopolitical risk from the conflict in the Middle East, the 
presidential elections in the United States in 2024, Russia’s continuing unjustified 
war against Ukraine and ongoing tensions between the United States and China. On 
the back of a weak economy and stubbornly high core inflation, turbulence in 

1    For comparison, the September 2023 ECB staff macroeconomic projections forecast annual headline 

inflation of 3.2% in 2024 and 2.1% in 2025. 

Financial Stability Review, November 2023 – Macro-financial and credit environment 

17 

-202468101212/2003/2106/2109/2112/2103/2206/2209/2212/2203/2306/2309/23Headline inflationCore inflation0102030405060708090100202320242025>= 4.53.5 to 4.42.5 to 3.4<2.40102030405060708090100Jan.Feb.Mar.Apr.MayJuneJulyAug.Sep.Oct.Nov.Dec.202320222021Historical range 2010-22 
 
 
 
 
 
financial markets due to geopolitical tensions could easily exacerbate downward 
risks for economic growth and financial stability in the euro area. Currently, a further 
escalation of the conflict in the Middle East could induce instability through higher 
energy prices, with serious implications for inflation and potentially for monetary 
policy. Additionally, an escalation may also depress consumer sentiment and 
investor risk appetite, adversely impacting growth prospects in the euro area. 

1.2 

Sovereign vulnerabilities remain elevated due to higher 
refinancing costs and a weak macro-financial outlook 

Stress in sovereign bond markets has generally receded, but risks remain 
elevated. Since the publication of the previous Financial Stability Review in May 
2023, stress levels in sovereign bond markets have declined. Nevertheless, the 
dispersion across countries started to rise again at the end of September (Chart 1.3, 
panel a). As there are considerable differences across euro area countries and 
downside risks to fiscal positions, stress could increase again, especially if market 
participants perceive budget planning in some countries to be detrimental to longer-
term debt sustainability. Overall, the euro area budget deficit is projected to decline 
over the coming years, accompanied by a tightening of the fiscal stance.2  Such a 
tightening would help to ensure that fiscal policies are better aligned with the 
monetary policy response to inflation. While the expected phasing-out of government 
support measures introduced in response to the energy price shock and high 
inflation could help to achieve a tightening of the fiscal stance, governments might 
counteract this effect by introducing new stimulus measures in response to a 
stronger deterioration in economic activity, for example, or a renewed increase in 
energy prices. In addition, there are risks of delays in the implementation of the Next 
Generation EU programme, which may weigh on national sovereign budgets going 
forward, while heightened geopolitical tensions could require increases in defence 
spending. 

The ongoing negotiations on reforming EU fiscal rules are inducing significant 
uncertainty. As the general escape clause contained in the EU’s Stability and 
Growth Pact will be deactivated by the end of 2023, reaching agreement is critical in 
order to anchor expectations for debt sustainability and sustainable, inclusive growth. 
Failure to swiftly agree on and put in place a credible, transparent and predictable 
fiscal framework could create uncertainty and unduly delay necessary fiscal 
adjustment and the impetus for reforms and investment.3  Such uncertainty would 
likely lead to further increases in government bond yields and spreads (Chart 1.3, 
panel b), especially for countries that may then fail to comply with the Stability and 
Growth Pact and face excessive deficit procedures. 

2    The September 2023 ECB staff macroeconomic projections forecast a decline in the euro area budget 
deficit to 3.2% of GDP in 2023 and 2.8% of GDP in 2024, followed by an increase to 2.9% of GDP in 
2025. See Economic Bulletin, Issue 6, ECB, September 2023. 

3    See the Opinion of the European Central Bank of 5 July 2023 on a proposal for economic governance 

reform in the Union (CON/2023/20) (OJ C 290, 18.8.2023, p. 17). 

Financial Stability Review, November 2023 – Macro-financial and credit environment 

18 

 
 
 
Chart 1.3 
Stress in sovereign bond markets has receded, but uncertainty remains high 

a) Euro area sovereign composite indicator of 
systemic stress 

b) Ten-year government bond yields by rating 
group 

(1 Jan. 2015-14 Nov. 2023, index) 

(1 Jan. 2020-14 Nov. 2023; left-hand scale: percentages, right-
hand scale: basis points) 

Sources: ECB, Bloomberg Finance L.P., LSEG, S&P Global Market Intelligence, Moody’s Analytics, Fitch Ratings and ECB 
calculations. 
Notes: Panel a: the sovereign composite indicator of systemic stress is unit-free and lies within the interval (0, 1). The indicator is 
available for 11 euro area countries: Belgium, Germany, Ireland, Greece, Spain, France, Italy, the Netherlands, Austria, Portugal and 
Finland. See Garcia-de-Andoain, C. and Kremer, M., “Beyond spreads: measuring sovereign market stress in the euro area’’, 
Economics Letters, Vol. 159, 2017, pp. 153-156. Panel b: government bond yields are weighted by annual GDP as at 2022. Ratings 
refer to the average from Moody’s, Standard & Poor’s and Fitch and represents the ratings as at 14 November 2023. 

The euro area sovereign debt-to-GDP ratio declined further but is expected to 
remain above pre-pandemic levels over the medium term. The euro area 
government debt-to-GDP ratio has benefited from a favourable interest rate-growth 
differential (the snowball effect) over recent quarters and is expected to fall to 89% in 
2023, significantly below the peak seen during the pandemic. In the light of upward 
pressure from primary deficits and positive deficit-debt adjustments, as well as a 
narrowing of the snowball effect, the ratio is projected to stabilise at around 88% 
over the course of 2024 and 2025, above the pre-pandemic level of 84%.4  While the 
situation differs across euro area countries, debt levels generally remain elevated. 

Sovereign debt service is still benefiting from the favourable financing 
conditions of the past but might face greater challenges in the future. Net debt 
issuance by euro area governments has been stable throughout 2023 – in line with 
previous years. With the Eurosystem reducing its footprint in sovereign bond 
markets, private sector actors like banks, non-bank financial institutions and foreign 
investors have stepped in to absorb fiscal issuance (Box 1). However, sentiment 
among such investors could change if fiscal policies in some euro area countries 
were perceived as detrimental to longer-term debt sustainability. During the 
pandemic, governments used favourable financing conditions to extend the maturity 
profile of their outstanding debt, helping to reduce refinancing risks going forward. 
While the currently higher interest rates feed slowly through to sovereign debt 

4    See “ECB staff macroeconomic projections for the euro area, September 2023”, published on the 

ECB’s website on 14 September 2023. 

Financial Stability Review, November 2023 – Macro-financial and credit environment 

19 

0.00.10.20.30.40.50.60.70.80.91.0201520162017201820192020202120222023Euro areaMinimum-maximum country range-50050100150200250-10123452020202120222023Countries rated AAA to AA-Countries rated A+ and belowSpread between lower-and higher-rated countries (right-hand scale) 
 
 
 
 
stocks, governments have broadly maintained the same maturity profile (Chart 1.4, 
panel a). At the same time, yields in sovereign bond markets are around 1.5 
percentage points above the average yield on debt portfolios, indicating significant 
potential for increases in the interest burden as maturing debt is rolled over (Chart 
1.4, panel b). Countries with higher short-term refinancing needs are likely to see a 
faster increase in their interest burden, which may pose challenges going forward. 

Chart 1.4 
Sovereigns have extended their debt maturity, but higher interest rates will increase 
their interest burden going forward 

a) Average yield and residual maturity on the 
outstanding debt of euro area governments 

b) Spread between current and average yields 
on outstanding government bonds and gross 
debt service due in one year   

(Jan. 2011-Sep. 2023; years, percentages) 

(Q2 2023, Sep. 2023; percentages of GDP, percentage points) 

Sources: ECB (GFS), LSEG, Bloomberg Finance L.P. and ECB calculations. 
Notes: Panel b: the y-axis shows the difference between ten-year government bond yields and the average yield of the outstanding 
debt portfolio as at September 2023. Data for debt service due in one year refer to September 2023; data for the debt-to-GDP ratio 
refer to the second quarter of 2023. 

Overall, risks to sovereign debt sustainability appear to be manageable in the 
short run, but medium-term challenges could add to financial stability risks. 
While debt levels in the euro area have stabilised, medium- and longer-term 
challenges such as geopolitical risks, climate change and ageing populations are 
adding to sovereign vulnerabilities. These challenges underline the need for a robust 
EU framework for economic and fiscal policy coordination and surveillance. The 
outlook for sovereigns may deteriorate if financial conditions tighten further, which 
would increase governments’ interest burdens, especially for sovereigns with high 
refinancing needs. In particular, debt sustainability concerns may arise going forward 
if governments do not pursue fiscally prudent paths or if highly indebted countries do 
not sufficiently reduce their debt ratios.   

Financial Stability Review, November 2023 – Macro-financial and credit environment 

20 

1.52.02.53.03.54.04.55.06.06.57.07.58.08.5Average yieldAverage residual maturityJanuary 2011-February 2020March 2020-June 2022July 2022-September 2023BEFRESPTITGRDESIHRFIATCYEALULTLVIENLMTSK0.00.51.01.52.02.53.03.50510152025SpreadDebt service due in one yearDebt-to-GDP > 100%Debt-to-GDP between 60% and 100%Debt-to-GDP < 60% 
 
 
 
Box 1 
Sovereign bond markets and financial stability: examining the risk to absorption capacity 

Prepared by Pablo Anaya Longaric, Maciej Grodzicki, Christoph Kaufmann, Allegra Pietsch, Pablo Serrano 
Ascandoni, Manuela Storz and Elisa Telesca 

The smooth absorption of sovereign debt issuance by the financial sector is essential for 
financial stability. Sovereign bonds are widely used as high-quality liquid assets and their prices 
serve as benchmarks for the pricing of various financial contracts. This means that the capacity of 
investors to absorb additional issuance is key for the orderly functioning of sovereign bond markets. 
Market conditions may have been impacted by reduced demand for government bonds as net 
purchases of sovereign debt by the Eurosystem came to a halt at the end of June 2022.5  At the 
same time, the supply of government bonds is expected to remain high. Against this background, 
this box proposes a framework for assessing the potential challenges to financial stability related to 
the limits of the absorption capacities of different sectors active in sovereign bond markets. 

Chart A 
Positive net sovereign debt issuance has been absorbed smoothly, with banks’ sovereign bond 
holdings mostly remaining at historical lows relative to their capital 

a) Newly issued debt securities by euro area 
sovereigns and purchases by sector 

b) Bank holdings of euro area sovereign bonds 
relative to total Tier 1 capital, by holder country 

(Q1 2019-Q2 2023, € billions) 

(Q4 2014-Q2 2023, percentages) 

Sources: ECB (SHS, CSDB, supervisory data) and ECB calculations. 
Notes: Panel a: “Other euro area” includes all other euro area sectors. Panel b: based on a balanced sample of 96 euro area significant institutions at the 
highest level of consolidation. “Other” includes Estonia, Cyprus, Lithuania and Malta. Spanish data are partly distorted by a merger which took place between 
significant institutions in 2021. 

Newly issued government debt has been absorbed smoothly so far in 2023, despite the 
absence of net central bank purchases. During the first half of the year, banks, investment funds, 
pension funds and households continued to purchase euro area sovereign bonds, while insurance 
corporations slightly reduced their exposures (Chart A, panel a). At the same time, foreign investors 
recommenced taking exposures towards euro area sovereign debt.6  While euro area banks have 

5    The Eurosystem currently has a fully passive run-off of its public sector purchase programme (PSPP), 
while it intends to reinvest maturing bonds under the pandemic emergency purchase programme 
(PEPP) until at least 2024. 

6    See the box entitled “Do global investment funds have a stabilising effect on euro area government 

bond markets?”, Financial Stability Review, ECB, May 2023. 

Financial Stability Review, November 2023 – Macro-financial and credit environment 

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-300-200-1000100200300400500600700Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q220192020202120222023BillionsEurosystemBanksInvestment fundsInsurance corporationsPension fundsHouseholdsForeign investorsOther euro areaNet issuance050100150200250PTGRITESOtherSIEABELUFRIEDEATNLLVFIMin.-max. rangeLatest observation (Q2 2023) 
 
 
 
 
recently increased their sovereign debt holdings, overall exposures to euro area sovereigns relative 
to their regulatory capital remained, on average, at multi-year lows as of mid-2023 (Chart A, panel 
b). 

Sovereign debt absorption patterns in 2023 have been in line with empirical evidence, which 
suggests that investors tend to increase their bond purchases when yields rise.7  Demand 
elasticities in respect of bond yields – which change inversely with prices – tend to be lower for 
lower-rated sovereign debt (Chart B, panel a). The analysis provides causal evidence that if 
sovereigns issue large amounts of debt, the absorption of such debt will take place at relatively 
higher yields. Higher yields may have played a key role in attracting foreign investors, who tend to 
be especially yield-sensitive, back to investing in higher-rated sovereign debt (Chart A, panel a). By 
contrast, households tend to show relatively high demand for the debt of lower-rated countries 
when yields on such debt increase and interest rates on deposits rise gradually. 

Chart B 
Rising euro area yields provide an incentive to absorb an increased net supply of sovereign bonds, 
while greater financial market uncertainty reduces absorption capacity for most financial sectors 

a) Estimated changes in nominal bond holdings after 
a 1 percentage point increase in yields 

b) Estimated changes in nominal bond holdings after 
a 1% increase in financial market uncertainty 

(Q2 2014-Q4 2022, € billions) 

(Q2 2014-Q4 2022, € billions) 

Sources: ECB (SHS, CSDB) and ECB calculations. 
Notes: Bars show estimated absolute changes in sectoral holdings due to a change in yields or in uncertainty. Estimates are obtained from separate 
regressions for each euro area sector and asset rating class where the dependent variable is the log of nominal bond holdings. Absolute changes are 
calculated from Q3 2022 levels. Shaded bars indicate statistically insignificant coefficients. “Lower-rated EA sovereign debt” refers to debt issued by euro area 
countries with a credit rating below AA- (Ireland, Greece, Spain, Italy, Cyprus and Portugal). The sample includes observations between Q2 2014 and Q4 
2022. All regressions include a constant, security and holder area fixed effects, yield to maturity, US ten-year yields to proxy returns on alternative foreign 
assets and “financial market uncertainty”, as measured by the VSTOXX volatility index. Yield to maturity is instrumented by high-frequency yield data on ECB 
Governing Council meeting dates taken from Altavilla, C. et al., “Measuring euro area monetary policy”, Journal of Monetary Economics, Vol. 108, December 
2019, pp. 162-179. 

The absorption capacity of non-bank investors tends to decrease in times of elevated 
financial market uncertainty. Except for banks, all sectors tend to reduce their exposures to euro 
area sovereign debt when market volatility rises. Volatility often coincides with higher liquidity 

7    The framework used in this box is an econometric estimation of an asset demand system based on 

empirical euro area bond holdings data by sector between Q2 2014 and Q4 2022, akin to that in Koijen, 
R. et al., “Inspecting the mechanism of quantitative easing in the euro area”, Journal of Financial 
Economics, Vol. 140, 2021, pp. 1-20. See also “The Eurosystem’s asset purchase programme, risk-
taking and portfolio rebalancing”, Financial Stability Review, ECB, May 2019. 

Financial Stability Review, November 2023 – Macro-financial and credit environment 

22 

020406080100120140160180Higher-rated EA sovereign debtLower-rated EA sovereign debtBillionsBanksInvestment fundsInsurance corporationsPension fundsHouseholdsForeign investors-80-60-40-2002040Higher-rated EA sovereign debtLower-rated EA sovereign debtBillionsBanksInvestment fundsInsurance corporationsPension fundsHouseholdsForeign investors 
 
 
 
 
needs, such as those experienced due to investor outflows, and comparatively risk-averse sectors, 
such as insurers, may show a stronger reduction in sovereign bond holdings (Chart B, panel b).8   

Accounting regimes and leverage requirements influence the capacity of banks to absorb 
sovereign debt. Unlike most institutional investors, banks can place sovereign bonds in their 
amortised-cost portfolios to lock in yields. As long as the credit risk of these bonds remains low, this 
accounting method reduces the volatility of banks’ profits and regulatory capital. This allows banks 
to invest in sovereign bonds in periods of high market uncertainty, while their aggregate holdings do 
not seem to be sensitive to yield levels.9  However, holding government debt at historical values can 
create a gap between a bank’s economic value and its book value, which could render it vulnerable 
to confidence shocks. Moreover, a low Tier 1 leverage ratio reflects a bank’s weak financial health 
and limited balance sheet capacity, and is found to be linked to lower purchases (Chart C, panel a). 
Nonetheless, this constraint may have been less binding recently than in the past, given the low 
level of banks’ sovereign bond holdings (Chart A, panel b). A high liquidity coverage ratio indicates 
that banks have limited need for liquid assets and is associated with lower net purchases of 
sovereign debt.   

Chart C 
Banks’ absorption capacity depends on regulatory metrics, while they compensate for other 
financial investors in times of elevated market volatility 

a) Coefficients of a regression of quarterly nominal 
bank holdings at the group-bond-portfolio level on 
selected variables 

b) Model prediction of sectoral absorption and yield 
changes after higher issuance announcement and 
financial market volatility shock 

(Q1 2016-Q4 2022, percentages) 

(left-hand scale: percentages, right-hand scale: percentage points) 

Sources: ECB (SHS, CSDB, supervisory data), Bloomberg Finance L.P. and ECB calculations. 
Notes: Panel a: all coefficients are significant at (at least) the 5% level. The dependent variable is the logarithm of nominal amounts held at the group-bond-
portfolio level by accounting treatment. Coefficients indicate the percentage change in nominal holdings in response to a one standard deviation increase in 
the explanatory variables. The credit spread is the bond-specific quarterly yield to maturity over the German government bond yield curve. The coefficient on 
credit spreads is estimated through an interaction between the accounting treatment and credit spreads. Control variables include an amortised-cost 
accounting dummy, the logarithm of banks’ total assets and total government bond holdings, GDP growth and the ECB’s deposit facility rate. Panel b: 
projection of sectoral absorption and expected yield changes using the demand functions estimated in Chart B (panels a and b). The scenario is a 
hypothetical announcement of additional government bond issuance equivalent to a 1.5% increase in debt outstanding in higher-rated (€90 billion) and lower-
rated (€60 billion) countries. The uncertainty shock is proxied by a one standard deviation increase of the VSTOXX volatility index. Projections are calculated 
on the assumption that the government bond market clears: yields adjust such that total net issuance equals the sum of total purchases or sales of all sectors 
based on their estimated demand elasticities for given changes in volatility and foreign yields. 

8    See Fache Rousová, L. and Giuzio, M., “Insurers’ investment strategies: pro- or countercyclical?”, 

Working Paper Series, No 2299, ECB, July 2019. 

9    Banks tend to increase their share of holdings measured at amortised cost and reduce their share of 

holdings marked to market when sovereign spreads are high. 

Financial Stability Review, November 2023 – Macro-financial and credit environment 

23 

-0.10.00.10.20.30.40.50.60.7Credit spreadTier 1 leverageratioShare of depositsin fundingLiquiditycoverage ratioChange in holdings at fair valueChange in holdings at amortised costChange in total holdings-0.10.00.10.20.30.40.50.60.70.80.91.0-100102030405060708090100Issuance shock+ uncertaintyshockIssuance shock+ uncertaintyshockHigher-rated countriesLower-rated countriesBanksInvestment fundsInsurance corporationsPension fundsHouseholdsForeign investorsOtherYield change (right-handscale) 
 
 
 
 
Higher government funding needs, especially in an environment of high market volatility, 
can imply rising yield levels and spreads. Simulations based on the framework presented in this 
box10  (Chart B) show that investors would be willing to absorb additional government bond 
issuance, equivalent to a 1.5% increase in outstanding debt in the euro area, at a higher yield 
(Chart C, panel b). They also indicate that the increase in yields would be greater in lower-rated 
countries than in higher-rated countries. Were such additional issuance to coincide with higher 
financial market volatility, equivalent to a one standard deviation increase of the VSTOXX volatility 
index, historical patterns suggest that banks would partially compensate for the reduced demand 
from other sectors. This would provide support to markets and ensure the ability of sovereigns to 
place the increased supply of debt. At the same time, it would further increase the close links 
between the banking system and sovereigns, which could reignite the negative feedback loop 
between these two sectors. Higher rates on government debt could, in turn, also tighten private 
sector financing conditions, especially in lower-rated countries. Spreads on lower-rated sovereign 
debt could rise further, exposing its holders to market risk effects. This box thus highlights the 
importance of interactions between fiscal policy and financial stability. 

1.3 

Tight financial conditions are starting to weigh on the debt 
servicing capacity of non-financial corporations 

Euro area non-financial corporations (NFCs) entered the hiking cycle with 
resilient balance sheets, but activity is slowing in several sectors. A long period 
of ultra-low interest rates and a strong post-pandemic recovery helped the average 
corporate to build resilience. Euro area firms benefited from strong gross profits 
throughout the first half of 2023, reflecting continued rises in selling prices. This was 
also facilitated by firms maintaining their profit margins at stable levels (Chart 1.5, 
panel a). Growth has come to a halt across most sectors as the effects of the 
recovery have faded and the impact of tighter financial conditions has increased. So 
far, service-oriented sectors have not been as badly affected, but some industrial 
sectors are already contracting (Chart 1.5, panel b). Uncertainty around the future 
path of this slowdown persists. Downside risks could materialise, especially if 
inflation remains too high for too long and triggers a further tightening of financial 
conditions or if an external shock hits. This might take the form of renewed 
substantial rises in energy prices or supply bottlenecks, possibly driven by 
geopolitical tensions. 

10    As elasticities are largely calibrated on the low-for-long environment, projections should not be seen as 

definitive as they may differ in times of lower excess liquidity.   

Financial Stability Review, November 2023 – Macro-financial and credit environment 

24 

 
 
 
 
Chart 1.5 
Firms maintain profit margins, but growth is slowing 

a) Profit margins across EURO STOXX 
sectors 

b) Growth in gross value added 

(Q1 2007-Q3 2023, percentages) 

(Q1 2022-Q2 2023, percentages) 

Sources: Bloomberg Finance L.P., Eurostat and ECB calculations. 
Notes: Panel a: the ranges in the chart cover the 17 non-financial sectors of the 20 sector indices that comprise the EURO STOXX 
Index. Panel b: growth in gross value added is shown as quarter-on-quarter changes in calendar-adjusted and seasonally adjusted 
gross value added. 

Firms have limited their borrowing in a climate of rising financing costs, 
causing leverage to decline. The increases in corporates’ financing costs over the 
past few months reflect the smooth transmission of monetary policy. The resulting 
tightening of credit standards by banks has been compounded by a drop in firms’ 
demand for external financing and has led to a material decline in lending volumes. 
Since the beginning of 2023, net borrowing from banks and net issuance of debt 
securities has almost come to a halt (Chart 1.6, panel a). The lower demand for 
credit also mirrors the greater availability of internal sources to fund capital 
expenditures, such as ample cash buffers and solid retained earnings built up during 
the post-pandemic recovery. The decline in new borrowing has also allowed the 
corporate sector to further deleverage, reducing gross debt11  to 131% of gross value 
added in the second quarter of 2023, down by 10 percentage points year on year 
and below pre-pandemic levels. 

11    For the definition of gross debt, see the notes to Chart 1.6, panel b. 

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25 

-202468101214161820072009201120132015201720192021202310-90th percentile rangeInterquartile rangeEURO STOXX Index aggregate-0.50.00.51.01.5Q1 22Q2 22Q3 22Q4 22Q1 23Q2 23AgricultureIndustry excluding constructionConstruction and real estateWholesale and retailInformation and communicationFinance and insuranceProfessional services, public administration and otherTotal 
 
 
 
 
Chart 1.6 
Demand for bank loans stalls in a climate of rising interest rates and weakening debt 
service capacity 

a) Borrowing costs, yearly cumulative net 
flows of bank borrowing and debt security 
issuance of euro area NFCs 

b) Share of variable-rate lending and interest 
coverage ratios 

(Jan. 2021-Sep. 2023; € billions, percentages) 

(Q2 2023; percentages, ratio) 

Sources: ECB (CSEC, BSI, MIR), Eurostat and ECB (QSA) and ECB calculations. 
Note: Panel a: flows of bank loans are adjusted for loan sales and securitisation (resulting in derecognition from the MFI statistical 
balance sheet) as well as for positions arising from notional cash pooling services provided by monetary financial institutions. Net 
issuance of debt securities refers to the difference in gross issues and redemptions of debt securities by euro area NFCs at face value. 
Panel b: the x-axis shows the average of monthly shares of variable-rate loans and loans with an interest rate fixation period of up to 
one year in total new lending between January 2018 and September 2023. The interest coverage ratio is calculated as the four-quarter 
moving sum of the gross operating surplus of NFCs divided by the four-quarter moving sum of interest before the financial 
intermediation services indirectly measured (FISIM) allocation payable by NFCs. Gross debt is unconsolidated and comprises the sum 
of loans granted to NFCs, debt securities issued by NFCs and insurance, pension and standardised guarantee schemes of NFCs 
minus loans granted by NFCs. GVA stands for gross value added. 

The debt servicing capacity of some firms may become a concern as higher 
interest rates feed through to corporate debt stocks. Prior to and during the 
pandemic, firms benefited from low interest rates, which helped to push interest 
coverage ratios up and default risks down. Because corporates generally have a 
larger share of adjustable-rate loans, they are affected by interest rate changes more 
quickly than other economic sectors. While the aggregate interest coverage ratio of 
euro area firms remained solid at 9.3 in the second quarter of 2023, higher interest 
expenses have already pushed it down by 2.7 percentage points compared with a 
year before. Interest expenses are expected to increase further with successive 
repricing of the loan stock. This may raise concerns over corporates’ debt servicing 
capacity, especially where debt levels are high and interest coverage ratios are low 
(Chart 1.6, panel b). 

Although generally still low, bankruptcies have started picking up, with some 
euro area countries seeing pre-pandemic levels surpassed. The more 
challenging macro-financial conditions, together with vulnerabilities built up over the 
pandemic, have led to an increase in insolvencies across countries (Chart 1.7, panel 
a). While this partly reflects the reduction of the insolvency backlog that accumulated 
during the pandemic, defaults are likely to rise further, with high-frequency indicators 
suggesting that the economic downturn is becoming more broad-based across 
countries and sectors (Chart 1.7, panel b). Default risk could particularly affect firms 

Financial Stability Review, November 2023 – Macro-financial and credit environment 

26 

-101234567-5005010015020025030035001/2104/2107/2110/2101/2204/2207/2210/2201/2304/2307/23ThousandsBorrowing from banks (adjusted loans)Net issuance of debt securitiesBank lending rate (right-hand scale)FRBEDENLEAITESIEATFI05101520255060708090100Interest coverage ratioSize of the bubble: gross debt-to-GVA ratioShare of variable-rate loans (average since 2018) 
 
 
 
that have not recovered from the strains inflicted by the pandemic and last year’s 
energy price shock and could increase should energy prices take off again. 

Chart 1.7 
Bankruptcies are increasing as the outlook for economic growth deteriorates 

a) Corporate bankruptcies 

b) PMIs across sectors and countries 

(Q4 2019-Q2 2023; index: Q4 2019 = 100) 

(index) 

Sources: Eurostat, INE, S&P Global Market Intelligence and ECB calculations. 
Notes: Panel a: the bankruptcy index provided by Eurostat for Spain shows a sizeable pickup in Spanish bankruptcies, driven largely 
by sole proprietors, the removal of the bankruptcy moratorium in June 2022 and the amended Spanish Bankruptcy Law which entered 
into force on 26 September 2022. To ensure comparability with the indices for other countries, the chart shows Spanish bankruptcies 
obtained from INE that exclude natural persons. The euro area aggregate is calculated using the INE data for Spain. Panel b: points 
show euro area countries for which sectoral PMIs are available. For the manufacturing PMI, these comprise the euro area aggregate, 
Germany, Ireland, Greece, Spain, France, Italy, the Netherlands and Austria; for the services PMI, they comprise the euro area 
aggregate, Germany, Ireland, Spain, France and Italy; and for the construction PMI, they comprise the euro area aggregate, Germany, 
France and Italy. Dots below the 45-degree line signal a deterioration between the two points in time. Values below 50 signal a 
contraction of output, values above 50 an expansion. 

Overall, corporate vulnerabilities have increased as financial conditions have 
tightened and the economic outlook has weakened. There is considerable 
diversity across firms, despite them being resilient on average, as higher financing 
costs and a weakening macroeconomic outlook are now adding to the challenges 
they have faced over the past few years. The interest burden for corporates will likely 
increase further as debt has to be refinanced at higher rates once sources of internal 
funding have been depleted. In addition, some debt instruments, such as leveraged 
loans, are more sensitive to rate increases and might be particularly exposed should 
financial conditions tighten further. This means that the number of vulnerable firms 
that have difficulty servicing their debt is likely to increase. Accordingly, there could 
be more defaults going forward, with potential knock-on effects on bank balance 
sheets, non-bank investors in corporate debt (Chapter 4) and household 
employment prospects. 

1.4 

Households benefit from a strong labour market but face 
higher debt service costs 

Euro area households continue to benefit from record levels of employment 
and, more recently, rising wages. Consumer confidence and households’ self-

Financial Stability Review, November 2023 – Macro-financial and credit environment 

27 

020406080100120140160Q419Q120Q220Q320Q420Q121Q221Q321Q421Q122Q222Q322Q422Q123Q223EADEESFRITNL354045505560354045505560October 2023May 2023ManufacturingServicesConstruction 
 
 
 
reported financial situations had been improving since the publication of the previous 
issue of the Financial Stability Review on the back of a very robust labour market 
and declining headline inflation. However, this improvement came to a halt in July 
2023 before going into reverse and remaining markedly below pre-pandemic levels 
(Chart 1.8, panel a). After real compensation per employee suffered a substantial fall 
in 2022, negotiated wages have picked up significantly recently. While no concrete 
signs of the labour market turning have emerged as yet, the rate of change in the 
unemployment rate has flattened out in recent months and the number of people 
unemployed has slowly started to rise in some countries. The sound financial 
position of households overall is mirrored by the household vulnerability indicator, 
which stands below its long-run average (Chart 1.8, panel b). 

Chart 1.8 
Households benefit from a strong labour market, but prospects are subdued as initial 
signs of higher debt service costs emerge and the unemployment rate bottoms out 

a) Consumer confidence, households’ 
expectations about their financial situation, 
and unemployment rate 

b) Composite indicator of household 
vulnerabilities 

(Jan. 2006-Oct. 2023, left-hand scale: indices, right-hand scale: 
percentages) 

(Q1 2000-Q2 2023, standard deviations from long-run average) 

Sources: European Commission, Eurostat, ECB and ECB calculations. 
Notes: Panel a: the latest observation for the unemployment rate is for September 2023. Panel b: the composite indicator is based on 
a broad set of indicators along five dimensions: debt servicing capacity (measured by gross interest payments-to-income ratio, savings 
ratio and expectation of personal financial situation); leverage (gross debt-to-income and gross debt-to-total assets ratios); financing 
(bank lending rate, short-term debt-to-long-term debt ratio, quick ratio (defined as current financial assets/current liabilities) and credit 
impulse (defined as the change in new credit issued as a share of GDP)); income (real income growth and income-to-GDP ratio); and 
activity (labour participation rate and unemployment expectations). The indicators are standardised by transforming them into z-
scores, i.e. they are converted into a common scale with a mean of zero and a standard deviation of one. Composite sub-indicators 
are calculated for each of the five dimensions by taking the simple arithmetic mean of the respective underlying z-scores of the 
individual indicators. Finally, the overall composite indicator is obtained by equally weighting the composite z-scores of the five sub-
categories. Positive values indicate higher vulnerability, negative values lower vulnerability. 

Household vulnerabilities are rising slowly due to deteriorating debt servicing 
capacity as higher policy rates feed through. The sharp decline in loan demand 
triggered by rising policy rates since 2022 has led to a drop in household leverage, 
reducing overall vulnerabilities. Similarly, the household vulnerability indicator’s 
activity component reflecting the strong labour market is contributing to declining 
vulnerabilities. The income component is reverting to neutral territory, as real wages 
are catching up. However, the recent deterioration in households’ debt servicing 
capacity is adding to aggregate vulnerabilities. The significant increase in the cost of 

Financial Stability Review, November 2023 – Macro-financial and credit environment 

28 

678910111213-30-25-20-15-10-505200620082010201220142016201820202022Consumer confidenceFinancial situation over next 12 monthsUnemployment rate (right-hand scale)-1.2-0.8-0.40.00.40.81.220002003200620092012201520182021Composite indicatorDebt servicing capacityLeverageFinancingIncomeActivity 
 
 
 
borrowing in the euro area has recently started to have an impact on mortgage debt 
service costs. Variable-rate mortgages and fixed-rate mortgages at the end of their 
rate fixation period are being repriced at interest rates that are much higher than they 
were a year ago or at origination. Worse debt servicing capacities are also reflected 
in the recent increase in the interest debt service-to-income (IDSTI) ratio for the euro 
area (Chart 1.9, panel a), in particular for countries where variable-rate mortgages 
predominate, while for most traditionally fixed-rate countries the ratio remained 
largely unchanged (Special Feature B). 

Chart 1.9 
Euro area household sector buttressed by sufficient cash flows and savings, but 
increase in debt service cost will weigh on households’ financial situations 

a) Interest debt service-to-
income (IDSTI) ratio 

b) Share of illiquid 
households, by income 
quintile 

c) Wall of fixed-rate mortgage 
debt expiration 

(Q1 2003-Q2 2023, percentages) 

(2010-Q2 2023, percentages) 

(2023-38, percentages) 

Sources: ECB (nowcasted Household Finance and Consumption Survey) and ECB calculations. 
Notes: Panels b and c: the nowcasting methodology brings the most recent survey data from 2021 forward to Q2 2023 by micro-
simulating the development of individual households’ incomes, savings, expenditures and debt holdings according to aggregate 
macro-financial data. Structural shifts in aggregate employment and mortgage origination patterns are taken into account. A household 
is defined as illiquid when its income cash flow is negative after all expenses and its savings do not cover more than one month of total 
debt service. 

Households remain solvent despite first signs of higher debt service costs on 
variable-rate loans, while fixed-rate loans could pose a problem down the line. 
Micro-simulations using household survey data nowcasted to the first quarter of 2023 
reveal that the share of households with a debt service-to-gross-income ratio of 
above 30%, which indicates elevated risk of default, increased from 12% to 14% 
between the first quarter of 2022 and the second quarter of 2023. In some countries 
with a share of variable-rate mortgages that is very high by historical standards, the 
increase has been even greater. At present, however, the micro-simulations do not 
show signs of a substantial increase in the share of illiquid households, as free cash 
flows – supported by the tight labour market – and savings buffers – supported by 
legacy excess savings from the pandemic – have not yet become impaired (Chart 
1.9, panel b). During the period of ultra-low interest rates, households originated and 
refinanced large volumes of mortgages at very favourable conditions. That said, 

Financial Stability Review, November 2023 – Macro-financial and credit environment 

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1234567200320072011201520192023IDSTI euro areaIDSTI fixed-rate countriesIDSTI adjustable-rate countriesStart of hiking cycle024681012142010201420172021Q22023ELowest2nd3rd4thHighest1.01.52.02.53.03.54.0010203040506020232025202720292031203320352037Cumulative share of fixed-rate mortgage debt expiringMedian interest rate (right-hand scale)Cost of new borrowing, September 2023 (right-hand scale) 
 
 
 
 
estimates based on nowcasted survey data show that over 30% of the euro area’s 
outstanding fixed-rate mortgage stock is expected to expire within the next ten years 
(Chart 1.9, panel c). These mortgages have median interest rates of between 1.5% 
and 2.0%, and debt service payments would have to be recalculated at market rates 
when the interest rate fixation expires. Depending on the future average cost of 
borrowing at the time, this repricing could result in a significant surge in debt service 
costs in countries where fixed-rate mortgages predominate. Since inflated house 
prices have driven up mortgage volumes substantially in several countries, even 
more affluent households may become financially stretched by increasing total debt 
service costs.12 

Household debt service costs are expected to increase further, with 
associated risks for euro area financial stability; however, the most vulnerable 
households hold little debt. Lower-income households, which are benefiting in 
particular from strong labour markets, constitute by far the largest share of illiquid 
households. However, their debt share has been very stable over time and makes up 
only around 10% of euro area mortgage debt and 20% of consumer debt, effectively 
limiting banks’ exposure. Going forward, higher debt service costs from variable-rate 
loans (over the short to medium term) and from fixed-rate mortgages (over the 
medium to long term) pose an increasing threat to households’ financial health and 
hence to the stability of the banking system in the euro area. Strong labour markets 
and sufficient savings are currently preventing higher debt service costs from leading 
to more defaults. That said, debt service costs are expected to increase further, and 
the September 2023 ECB staff macroeconomic projections already predict a slight 
increase in the unemployment rate to 6.7% in 2024. A significant deterioration of 
labour market conditions may put even middle-income households at risk, however. 

1.5 

Euro area residential and commercial real estate markets 
are experiencing a downturn 

Euro area residential real estate (RRE) prices exhibited a year-on-year decline 
in the second quarter of 2023. The steep increase in borrowing costs since the 
beginning of the tightening cycle has had a negative impact on the demand for 
mortgages, leading to a sharp drop in new lending. The general level of interest 
rates, the reduction in consumer confidence and deteriorating housing market 
prospects are the main drivers behind the dwindling demand for housing loans. In 
line with falling new lending, euro area RRE price growth declined from 9.2% in the 
second quarter of 2022 to -1.7% in the second quarter of 2023. Model-based 
evidence suggests that monetary policy tightening is the main factor putting 
downward pressure on house prices, followed by changes in household preferences 
and tighter bank credit standards (Special Feature B). Although euro area RRE 
price dynamics only recently turned negative, prices had already started declining in 
some euro area countries in the second half of 2022. High-frequency data suggest 
that the pace of the decline in RRE prices has slowed over recent months (Chart 

12    Households can also renegotiate the schedule of principal payments and extend the duration of a 

mortgage. 

Financial Stability Review, November 2023 – Macro-financial and credit environment 

30 

 
 
 
1.10, panel a), indicating a price correction that has been orderly so far.13  Euro area 
rental prices, on the other hand, are rising at a record pace – in September 2023 
they were up 2.7% year on year. 

Chart 1.10 
RRE prices are declining at a slower pace, but valuations still seem stretched in 
several countries, suggesting that further price falls are likely 

a) High-frequency RRE prices in selected 
countries 

b) Overvaluation estimates across euro area 
countries 

(Dec. 2019-Aug. 2023; index: December 2019 = 100) 

(Q4 2019, Q2 2022, Q2 2023; percentages) 

Sources: ECB, Europace, Eurostat, Immobiliare.it, Meilleursagents.com, Confidencial Imobiliário, Arco Real Estate, Národná banka 
Slovenska, Statistics Finland, Irish Central Statistics Office and Statistics Netherlands. 
Notes: Panel a: the chart includes monthly data up to August 2023 for the following countries: Germany, Finland, France, Ireland, Italy, 
Latvia, Portugal and the Netherlands. For Slovakia, data are quarterly and up to June 2023. An average listing price index is used for 
Italy, while a hedonic price index based on transaction prices is used for all the other countries. Panel b: the chart shows deviations 
from the long-term average of the house price-to-income ratio, which constitute an indication of potential overvaluation in domestic 
housing markets. The long-term average is calculated from Q1 1996 to the respective end quarter. The average of two measures 
(inverted demand econometric model and house price-to-income ratio) was employed in previous editions of the Financial Stability 
Review, but the inverted demand model might underestimate overvaluation in a period of high inflation due to its use of real interest 
rates. Accordingly, the house price-to-income ratio is being employed as the benchmark overvaluation measure in the current edition 
of the Financial Stability Review. 

RRE valuations are still above pre-pandemic levels in several euro area 
countries, suggesting that vulnerabilities remain elevated. RRE prices grew at a 
fast pace during the coronavirus (COVID-19) pandemic, rising significantly quicker 
than household incomes, which, in turn, pushed up estimated valuations of housing 
prices. These remain significantly above pre-pandemic levels, despite the fall in RRE 
prices witnessed thus far in some euro area countries (Chart 1.10, panel b).14 
Higher interest rates are likely to result in further downward pressure on house 
prices as they weigh on demand for new loans, while the debt servicing capacity of 
households with outstanding mortgages could deteriorate (Section 1.4). This is 
especially the case in countries where valuations are stretched, debt levels are 
elevated, or household mortgage debt is largely composed of variable-rate loans. 
Indeed, banks still expect the demand for housing loans to decline in the fourth 
quarter of 2023, but at a slower pace than in the previous five quarters. Together 

13    Price growth has even turned positive again in some countries in recent months. 
14    The growth in nominal wages could also contribute to lower housing valuation estimates going forward, 

particularly if households continue to demand higher wages to compensate for inflation. 

Financial Stability Review, November 2023 – Macro-financial and credit environment 

31 

10010511011512012513013512/1906/2012/2006/2112/2106/2212/2206/23GDP-weighted euro area averageInterquartile range-20-100102030405060Q4 2019Q2 2022Q2 2023Euro area medianCountry interquartile range 
 
 
 
 
with supply-side shortages and high construction prices, this might contain the fall in 
RRE prices in the near term. 

The outlook for commercial real estate (CRE) firms has continued to 
deteriorate in a context of falling tenant demand and negative credit rating 
actions. Transaction activity in CRE markets remains subdued (-47% in the first half 
of 2023 compared with the first half of 2022), although this may change in the 
coming quarters as the future path of interest rates becomes clearer. Any increase in 
market activity will aid price discovery but may result in significant declines in 
transaction prices as the market prices in a year of monetary policy tightening. The 
effects of this tightening are amplified by falling demand for CRE assets in the wake 
of the pandemic, with demand for office space dropping significantly over the course 
of 2023 (Chart 1.11, panel a). This dual challenge has driven significant credit rating 
activity for real estate firms over recent months. For example, S&P has downgraded 
22% of European real estate firms since 2022 and a further 26% are on negative 
outlook. Looking at the combined actions of all credit rating agencies, market 
analysts estimate that €6 billion of bonds issued by European real estate firms were 
downgraded to high yield between May and August this year and that a further €10 
billion in bonds remain vulnerable. Conditions are particularly challenging for 
property developers, who face falling sales prices, contracting order books and rising 
input costs, although price pressure from input materials has reduced in recent 
months (Chart 1.11, panel b). These factors resulted in a number of smaller German 
developers filing for bankruptcy in September. Construction sector PMIs have 
deteriorated in recent months, although they remain far above the lows seen during 
the pandemic and the global financial crisis (Chart 1.11, panel b). 

Chart 1.11 
The outlook for CRE markets continues to deteriorate, with landlords facing falling 
demand and developers under additional pressure from input costs 

a) Change in number of tenancy enquiries in 
three months 

b) PMI for construction sector input prices 
and output 

(Q1 2008-Q2 2023, percentages) 

(Jan. 2007-Oct. 2023, index) 

Sources: RICS, ECB calculations and S&P Global Market Intelligence. 
Notes: Panel b: a value above 50 denotes an increase and a value below 50 denotes a decrease (in confidence or prices). PMI stands 
for Purchasing Managers’ Index. 

Financial Stability Review, November 2023 – Macro-financial and credit environment 

32 

-100-80-60-40-2002040608020082010201220142016201820202022IndustrialOfficeRetail0102030405060708090100200720092011201320152017201920212023Construction input prices PMIConstruction output PMI 
 
 
 
The implications of the ongoing real estate correction for financial stability 
critically depend on the extent to which tighter financial and credit conditions 
reduce real estate demand and affordability. The downward adjustment in RRE 
prices has so far taken place in an orderly manner. However, risks remain tilted to 
the downside, especially in those countries where debt levels are elevated and 
properties might be overvalued. The commercial segment has seen a steeper 
downturn, and the combination of rising financing costs and falling rental incomes 
could pose repayment capacity challenges. Despite negative credit rating actions, so 
far there is limited evidence of credit supply restrictions, fire sales or a widespread 
deterioration in credit quality among CRE firms. Banks’ aggregate exposures are 
substantially smaller for CRE than for RRE and are unlikely to be large enough at the 
euro area level to cause a systemic crisis alone. Nevertheless, a scenario where real 
estate firms suffer very large losses is likely to coincide with stress in other sectors. 
In this way, CRE market outcomes have the potential to act as a significant 
amplifying factor in an adverse scenario, increasing the likelihood of systemically 
relevant losses accruing in the banking system (Special Feature B). While 
macroprudential policy should focus on maintaining the resilience of the banking 
sector at the current juncture, current levels of banking sector profitability may 
provide an opportunity for further targeted increases of macroprudential buffers in 
some countries while avoiding procyclical effects (Chapter 5). 

Financial Stability Review, November 2023 – Macro-financial and credit environment 

33 

 
 
2 

Financial markets 

2.1 

Markets adjust to an environment of higher rates 

Market participants’ view that there is a heightened risk of persistent inflation 
has led them to revise their expectations for interest rates to remain elevated 
for a longer period of time. Falling inflation (Chart 2.1, panel a) has encouraged 
major central banks to moderate the pace of policy rate hikes. In addition, the 
prospect of nearing the end of the rate-hiking cycle lowered the implied volatility in 
risk-free interest rate markets and supported investor sentiment until August. At the 
same time, however, longer-term inflation swap forward rates have stayed elevated 

Financial Stability Review, November 2023 – Financial markets 

34 

ECB-RESTRICTED5Y5Y inflation swap forward ratesAverage maturity on outstanding high-yield bondsUS equity valuationsEquity risk premia vs growth outlookSlower growth may make risk premia widen“AI rally” raises overvaluation concernsMarkets are vulnerable to higher interest rates, slowing growth and geopolitical risks•Markets see high risk of elevated inflation •Refinancing risk rises for weaker borrowers•Slower growth may make risk premia widen•“AI rally” raises overvaluation concernsMarkets see high risk of elevated inflationRefinancing risk rises for weaker borrowersEuro area:3.5United States:4.9201520172019202120233.2%01/2311/23Long-term EUR forward ratesEuro area:2.4%United States:2.7%2020202120222023Since ChatGPT launch-2%-1%0%1%2%Forward P/E ratioReal risk-free rate (10Y)2023 YTD405060Equity risk premiumComposite PMI 
 
 
(Chart 2.1, panel a), as resilient labour markets, the energy transition, climate 
change and heightened geopolitical tensions may contribute to greater inflation 
persistence and economic uncertainty.15  Consequently, market participants have 
also adjusted their expectations regarding the future path of short-term interest rates 
and have priced them as remaining at elevated levels for an extended period of time 
(Chart 2.1, panel b). Over September and October a rapid increase in long-term 
government bond yields in line with this trend, as well as on the back of rising term 
premia, put renewed pressure on asset valuations. However, the market correction 
proved to be short-lived, as investor confidence benefited from a downside surprise 
in inflation. 

Chart 2.1 
Investor expectations of inflation persistence have led them to price in higher-for-
longer rates 

a) Headline inflation and longer-term inflation 
swap forward rates 

b) Market-implied short-term interest rate 
expectations 

(Jan. 2020-Nov. 2023, annual percentage changes) 

(percentages) 

Sources: Bloomberg Finance L.P. and ECB calculations. 
Notes: The latest observations are for 14 November 2023. Panel a: longer-term inflation swap forward rates refer to 5Y5Y swaps on 
HICP (euro area) and CPI (United States). Panel b: risk-neutral market expectations for one-month rates based on the €STR OIS and 
the USD SOFR OIS forward curves. 

A period of higher interest rates may bring long-term benefits for the stability 
of the financial system, but it could also temporarily increase market volatility. 
The era of ultra-low interest rates was associated with an accumulation of financial 
stability risks.16  In financial markets, these risks were linked primarily to search-for-
yield behaviour, resulting in increased leverage and exposure to risky assets and 
causing a build-up of market and credit risks that in some cases may have exceeded 
risk-bearing capacities.17  As a result, the transition to a higher interest rate 
environment has triggered a reversal which is visible in de-risking trends as safer 

15    See, for example, “Policymaking in an age of shifts and breaks”, speech by Christine Lagarde at the 
annual Economic Policy Symposium “Structural Shifts in the Global Economy”, Jackson Hole, 25 
August 2023. 

16    See, for example, “Macroprudential policy issues arising from low interest rates and structural changes 

in the EU financial system”, ESRB, November 2016. 

17    See, for example, Hermans, L., Kostka, T. and Vassallo, D., “Asset allocation and risk taking under 

different interest rate regimes”, Working Paper Series, No 2803, ECB, March 2023. 

Financial Stability Review, November 2023 – Financial markets 

35 

0.51.01.52.02.53.0-30369122020202120222023EA -headline inflationUS -headline inflationEA -longer-term inflation forward rates (right-hand scale)US -longer-term inflation forward rates (right-hand scale)2345606/2312/2306/2412/2406/2512/25EA -latest                                                                                          US -latestEA -31 May 2023US -31 May 2023 
 
 
 
 
assets have become increasingly appealing to investors (Chart 2.2, panel a). Net 
flows into investment funds exposed to riskier asset classes have also been 
substantially lower (Chapter 4). The crowding out of riskier assets has so far mostly 
been evident in primary market volumes, with the gross issuance of euro area high-
yield bonds and equities declining considerably during the normalisation of monetary 
policy (Chart 2.2, panel b). In the secondary market, the rise in real risk-free rates 
has induced a correction in equity prices, albeit of limited extent to date. Such 
resilience may be attributed partly to reduced supply from new issuance, on top of 
the robust demand stemming from the soft-landing expectations or from investors 
who see equities as a better inflation hedge than fixed income securities. Going 
forward, compressed risk premia leave global equity markets vulnerable to disorderly 
repricing if risk sentiment deteriorates. Such correction could be exacerbated by 
heightened leverage in the equity options market (Box 2). 

Chart 2.2 
The transition to a higher interest rate environment has reduced the issuance of 
riskier assets 

a) Real return and risk metrics for euro-
denominated asset classes 

b) Changes in gross issuance of securities by 
euro area entities 

(percentages) 

(Jan.-Nov., 2018-23; average for 2018-20 = 100) 

Sources: Bloomberg Finance L.P. and ECB calculations. 
Notes: The latest observations are for 14 November 2023. IG stands for investment grade; HY stands for high yield. Panel a: 
calculated on the basis of Bloomberg euro-denominated total return bond indices for three- to five-year maturities and on the EURO 
STOXX Index. Expected real returns are proxied by the weighted average yield to maturity adjusted by inflation swap rates on the euro 
area HICP matching index average maturity (for debt indices) and by the five-year cyclically adjusted price-to-earnings (CAPE) yield 
(for the equity index). Risk is proxied by the rolling five-year annualised volatility of monthly returns. Fitted lines are linear functions. 
Panel b: rating groups are based on the average rating assigned to a given issuer. 

The impact of policy tightening on riskier borrowers may be greater in the 
medium term. Lower-rated corporate borrowers issued a record amount of debt 
shortly before the onset of the tightening cycle (Chart 2.2, panel b). This may have 
enabled them to reduce issuance in 2022 and 2023 to some degree, which shielded 
them from the immediate effects of higher risk-free rates and wider spreads on their 
funding costs. Some firms which still opted for market-based funding have issued 
new bonds but with shorter maturities, potentially aiming to lower the risk premia 
demanded by investors or hoping that monetary policy would ease faster than 
currently anticipated (Chart 2.3, panel a). These two trends have recently caused 
the average maturity of outstanding high-yield debt to fall to historical lows (Chart 

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36 

Government bonds (IG)Corporate bonds (IG)Corporate bonds (HY)Equities-4-20246805101520Expected real return proxyRisk proxyNovember 2023December 2021020406080100120140160180200GovernmentbondsCorporatebonds (IG)Corporatebonds (HY)Equities202120222023Average for 2018-20 
 
 
 
2.3, panel b). While such debt management strategies could prove beneficial for 
borrowers if tight monetary policy is short-lived, they might increase rollover risks, 
especially in a higher-for-longer environment. In particular, shorter debt maturities 
leave lower-rated firms more exposed to future market conditions. If a delay in the 
impact of policy tightening on funding costs coincides with an already slowing 
economy, this could lead to a further rapid decline in interest coverage ratios 
(Chapter 1) and cause a disorderly price correction in the high-yield bond market. 

Chart 2.3 
High-yield issuers are increasingly exposed to refinancing risk 

a) High-yield bond issuance characteristics 

b) Average remaining maturity on outstanding 
high-yield bonds 

(2021-23 year to date; percentages, years) 

(Jan. 2015-Nov. 2023, years) 

Sources: Bloomberg Finance L.P. and ECB calculations. 
Notes: The latest observations are for 14 November 2023. Panel a: bubble size is scaled to reflect the notional amount of debt issued. 
Average characteristics are weighted by the amount issued. The calculation of average original maturity excludes perpetual bonds. 
Panel b: average maturity for the ICE BofA Euro High Yield Index (euro area) and the ICE BofA US High Yield Index (United States). 

Vulnerabilities are also persisting in sovereign bond markets due to the 
continued rise in risk-free rates and subdued economic growth. The period of 
ultra-low interest rates led to a gradual decline in the cost of public debt and reduced 
disparities in funding costs between euro area countries despite rating differences 
(Chart 2.4, panel a). The reversal of this trend since summer 2022 has been only 
gradual so far. It could, however, gain momentum, particularly as more vulnerable 
countries are confronted by substantial rollover needs in the near term (Chapter 1). 
At present it would appear that sovereign spreads are increasingly reflecting 
differences in country ratings and the outlook for these ratings, with more euro area 
sovereign debt at risk of a downgrade than an upgrade (Chart 2.4, panel b). Going 
forward, some euro area countries may experience significant spread widening if 
they are unable to consolidate their fiscal positions, although this may prove 
challenging given the ongoing economic slowdown. At the same time, the flexibility in 
the ECB’s pandemic emergency purchase programme reinvestments and the ECB’s 
Transmission Protection Instrument could mitigate unwarranted disorderly sovereign 
debt market dynamics that could pose a serious threat to the transmission of 
monetary policy across the euro area, if the programme conditions are fulfilled. 

Financial Stability Review, November 2023 – Financial markets 

37 

2021202220232021202220235.56.06.57.07.58.08.59.03456789Original maturityYield at issuanceEuro areaUnited States3.03.54.04.55.05.56.06.57.0201520162017201820192020202120222023Euro areaUnited States 
 
 
 
Chart 2.4 
Higher interest rates might strengthen market discipline of fiscal policies 

a) Sovereign financing costs, by rating, 
and ECB deposit facility rate 

b) Spreads for euro area sovereigns, by 
average rating and rating outlook 

(Jan. 2015-Sep. 2023; left-hand scale: percentages, right-hand 
scale: basis points) 

(14 November 2023; notches above investment-grade threshold, 
basis points) 

Sources: Bloomberg Finance L.P., ECB (CSDB), Fitch Ratings, Moody’s Analytics, S&P Global Market Intelligence and ECB 
calculations. 
Notes: Panel a: average yield at issuance for outstanding sovereign debt. “Medium and lower-rated countries” are defined here as 
those having at least one credit rating below Aa3 (Moody’s) or AA- (Fitch and S&P). Other euro area countries are considered to be 
higher rated. The spread shows the difference in average yield at issuance for the two groups indicated in the chart. Panel b: the 
highest possible rating (AAA/Aaa) equals 9. The fitted lines are linear functions for countries with positive (blue) and negative (red) 
outlooks. Average rating from Fitch, Moody’s and S&P. Bubble size is scaled to reflect the notional amount of debt outstanding as at 
the end of September 2023. 

Disruptions in the supply of energy commodities could push inflation up again 
and contribute to market volatility. The euro area has seen wide swings in the 
price of natural gas over the last two years and there is still considerable uncertainty 
surrounding future prices. Europe’s heavy reliance on liquified natural gas has 
rendered natural gas prices highly vulnerable to potential supply disruptions. Implied 
volatility metrics also indicate that risks are tilted to the upside. In addition, oil prices 
have risen since July 2023 on the back of concerns about reduced supply. Volatility 
in energy commodity prices might also rapidly increase in response to growing 
geopolitical tensions. A renewed energy price shock, triggered by geopolitical 
tensions in the Middle East for example, could lead to more persistent inflation, 
induce an adjustment in market-based interest rate expectations and further weaken 
economic growth. This could potentially lead to renewed market corrections. 

Box 2 
The risks from hidden leverage in short-term equity options 

Prepared by Andrzej Sowiński 

Option trading volumes in the euro area equity market could increase significantly in the 
coming quarters in response to the broader offer of such instruments. In the United States, 
there has been growing interest in trading S&P 500 options on the day of their expiry (commonly 
referred to as “0 days to expiry” or “0DTE”). In response, the Cboe Exchange has expanded the 

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38 

8090100110120130140150-10123456201520162017201820192020202120222023Higher-rated countriesMedium-and lower-rated countriesSpread (right-hand scale)ECB deposit facility rate020406080100120140160180200220-20246810Spread vs German bondsAverage ratingPositive outlookStable outlookNegative outlook 
 
 
 
offer of these options by adding expiration dates to include every business day.18  Since then, 
trading volumes for options on the S&P 500 have soared (Chart A, panel a). Recently they reached 
an all-time high, with 0DTE options accounting for more than 50% of total option volumes for this 
index. In anticipation of similar investor interest in trading 0DTE options in the euro area equity 
market, on 28 August 2023 EUREX expanded the offer of weekly options on the EURO STOXX 50 
to also cover every business day. 

Chart A 
Trading activity and leverage in the euro area equity option market might rise after EUREX 
expanded the offer of options on the EURO STOXX 50 to cover every business day 

a) Average daily trading volumes for options on 
equity indices and 0DTE options share 

b) Leverage ratios and hedge ratio sensitivities in 
call options on the EURO STOXX 50, by time to 
expiry 

(Jan. 2018-Oct. 2023; millions of contracts, percentages) 

(26 Oct. 2023; ratio, percentage points) 

Sources: Bloomberg Finance L.P., Cboe Global Markets and ECB calculations. 
Notes: Panel a: the latest observations are for 26 October 2023. “Complete 0DTE offer” marks the date from which options start to expire on each business 
day. Data on 0DTE share in S&P 500 option volume traded in 2023 show a year-to-date share at the end of August.* Panel b: the option leverage ratio (i.e. 
the option lambda parameter, or how much leverage market participants are employing while engaging in these trades) is calculated as the value of the delta-
equivalent position (i.e. the effective exposure in the underlying index) over the option price. Hedge ratio sensitivity (i.e. the option gamma parameter) is 
calculated as the sensitivity of the option delta parameter (i.e. how much an option price changes when the underlying equity index changes) to the level of 
the underlying index. A higher gamma implies higher volatility in option prices. At-the-money (ATM) and out-of-the-money (OTM) options represent options 
closest to 50% and 25% delta respectively. 
*) See “Volatility Insights: Evaluating the Market Impact of SPX 0DTE Options”, Cboe, 8 September 2023. 

Trading in 0DTE options is more cost efficient for market participants. A broader range of 
expiries gives market participants more flexibility, for instance if they want to hedge against or 
speculate on the immediate market impact of a specific macroeconomic data publication or policy 
decision. Since the timing of such events is known in advance, investors can open their positions on 
the same day, paying less in premia for the relevant 0DTE options than they would otherwise have 
done for longer-dated contracts. This feature makes them particularly attractive during periods of 
heightened economic uncertainty. 

Some characteristics of 0DTE options might, however, increase procyclicality in the equity 
market. The smaller premia paid for options with a shorter time to expiry mean the effective 
leverage embedded in these contracts is much higher (Chart A, panel b). This can magnify their 
impact on the underlying stock market because of the way exposures are managed by option 
sellers. Some traders only hedge their position after breaching a certain loss threshold. Others, 

18    Before 2022, contracts expired on Mondays, Wednesdays and Fridays. Tuesday and Thursday expiries 

were added on 18 April and 11 May 2022 respectively. 

Financial Stability Review, November 2023 – Financial markets 

39 

EURO STOXX 50 -complete 0DTE offerS&P 500 -complete 0DTE offer02040608001234201820192020202120222023EURO STOXX 50S&P 500S&P 500 -0DTE share in volume (right-hand scale)0102030405004080120160200ATMOTMATMOTMATMOTM4W + 1D1W + 1D1DTime to expiryLeverage ratioHedge ratio sensitivity (right-hand scale) 
 
 
 
 
such as market-makers (typically large banks or investment firms), tend to hedge their short 
positions swiftly, either by buying other options or trading the underlying securities, depending on 
the market situation. As the effective exposure stemming from options is sensitive to changes in the 
underlying index, the quantity of securities that must be bought or sold (the hedge ratio is 
determined by the option delta) also changes over the life of a contract. Sensitivity to changes is 
much higher for out-of-the-money options with a shorter time to expiry (Chart A, panel b). This 
means that the sellers of such 0DTE options might need to trade the underlying securities in a way 
which is very dynamic and in line with the short-term trend. In other words, they need to buy more 
and more when prices go up and sell more and more when prices go down. As a result, these 
transactions might fuel short-term price movements and amplify intraday volatility spirals. 

The potential for 0DTE options to affect the underlying equity market depends heavily on 
investors’ positioning. Option sellers hedge their positions at a portfolio level, and the hedging 
transactions of individual market participants might offset each other. This means that the aggregate 
market impact of these trades depends on the current structure of option exposures. If investors 
open similar positions in call and put options to a comparable degree, the initial impact on the 
underlying index might be negligible. Nevertheless, hedging trades might still affect short-term price 
developments over the life of these contracts. This effect is larger if market participants exploit 
higher leverage by choosing options with shorter maturities (Chart B, panel a) and out-of-the-
money options (Chart B, panel b). If, on the other hand, the market positioning becomes more one-
sided – meaning participants invest more in put (call) options – even the immediate market impact 
can become material (Chart B, panel c), and the potential for further impact in line with short-term 
price trends is skewed to the downside (upside). 

A build-up of exposures in 0DTE options might fuel disorderly market moves. Greater 
sensitivity of shorter-dated options to changes in the price of the underlying index might constitute a 
structural vulnerability. The potential impact of 0DTE options grows with the size of exposures in 
these instruments relative to the size of the underlying equity market. Such an impact might remain 
muted until a large, abrupt swing in investor sentiment occurs, when markets typically become one-
sided. Option sellers might then be forced to rapidly trade underlying securities in line with the 
short-term price trend. The expected deterioration in market liquidity conditions could also add to an 
adverse volatility spiral. In addition, some market participants – such as retail investors – might 
exploit this vulnerability by triggering or feeding a volatility spike through 0DTE options with the 
highest effective leverage.19  Although the number of such investors in this market segment remains 
small, their share is growing rapidly.20 

19    For more information on the potential role of retail investors in inducing forced equity trades (e.g. short 
squeeze), see, for example, Anand, A. and Pathak, J., “The role of Reddit in the GameStop short 
squeeze”, Economics Letters, Vol. 211, February 2022, and Vasileiou, E., “Does the short squeeze lead 
to market abnormality and antileverage effect? Evidence from the Gamestop case”, Journal of 
Economic Studies, Vol. 49, No 8, October 2022. 

20    See the box entitled “The Fast-Growing Interest in Retails’ Trading in the Zero-Day Options Market: Is It 

a Hidden Risk?’’, Global Financial Stability Report, International Monetary Fund, April 2023. 

Financial Stability Review, November 2023 – Financial markets 

40 

 
 
 
Chart B 
The potential impact of options on the underlying equity market depends on various factors 

a) Stylised simulation of hedging 
flows from a €1 million investment 
in EURO STOXX 50 options, by 
time to expiry 

b) Stylised simulation of hedging 
flows from a €1 million investment 
in EURO STOXX 50 options with 
one day to expiry, by moneyness 

c) Stylised simulation of hedging 
flows from a €1 million investment 
in EURO STOXX 50 options with 
one day to expiry, by put/call ratio 

(26 Oct. 2023; percentages, € millions) 

(26 Oct. 2023; percentages, € millions) 

(26 Oct. 2023; percentages, € millions) 

Sources: Bloomberg Finance L.P. and ECB calculations. 
Notes: Out-of-the-money (OTM), at-the-money (ATM) and in-the-money (ITM) options represent options closest to 75%, 50% and 25% delta respectively. 
“Estimated hedging flow” shows the values of the underlying securities that must be traded by option sellers to delta-hedge the option exposure. Other option 
parameters and characteristics (e.g. implied volatility) are assumed constant in the analysis. Panel a: investment amount assumed in the scenario is split 
equally between put and call ATM options. Panel b: investment amount assumed in the scenario is split equally between put and call options with one day to 
expiry. Panel c: investment amount assumed in the scenario is split between put and call OTM options with one day to expiry, in line with indicated put/call 
ratio. 

Risks for the euro area from 0DTE options also stem from the high level of integration with 
global equity markets. Although it is yet to be seen if interest in trading EURO STOXX 50 options 
on the day of their expiry will grow rapidly, the euro area equity market might experience a 
disorderly correction if risks associated with 0DTE options were to materialise in the United States. 
The correlation between the two markets tends to rise during stress events, so adverse spillover 
effects could be expected. In addition, a rapid deterioration of market sentiment abroad might 
interplay with vulnerabilities in the EURO STOXX 50 option market. Further monitoring of trading 
patterns in 0DTE options globally is therefore warranted. 

2.2 

Investors may be underestimating the risk of a slowdown 
in economic growth 

Elevated economic uncertainty could also lead to a surge in market volatility. 
Various shocks – such as credit events – can occur unexpectedly, while 
vulnerabilities tend to become more pronounced towards the end of a tightening 
cycle. Currently, the low levels shown by market-based risk indicators suggest that 
the baseline expectation among investors is that the economy will experience a soft 
landing, meaning that inflation will decline towards central bank targets without an 

Financial Stability Review, November 2023 – Financial markets 

41 

-150-100-50050100150-2-1012Estimated hedging flowChange in the underlying index1D1W + 1D4W + 1D-300-200-1000100200300-2-1012Estimated hedging flowChange in the underlying indexOTMATMITM-450-300-1500150300450-2-1012Estimated hedging flowChange in the underlying indexPut/call = 4Put/call = 1Put/call = 0.25 
 
 
 
 
 
accompanying recession.21  Nevertheless, the historical evidence indicates that a 
benign scenario of this type is difficult (although not impossible) to achieve in 
practice, especially given the magnitude of rate increases in a short period of time.22 
This underscores the fact that there are material risks surrounding current market 
pricing. In both the euro area (Chart 2.5, panel a) and the United States (Chart 2.5, 
panel b), market volatility and risk premia have tended to increase after a hiking 
cycle has concluded, albeit with different time lags. The potential underestimation of 
risk by market participants could therefore lead to a disorderly correction if there are 
any negative economic surprises or if market sentiment turns. 

Chart 2.5 
Economic uncertainty might lead to a spike in market volatility after rate hikes end 

a) Equity market-implied volatility and 
corporate bond spread around the end of 
hiking cycles in the euro area 

b) Equity market-implied volatility and 
corporate bond spread around the end of 
hiking cycles in the United States 

(Oct. 1998-July 2013; left-hand scale: index, right-hand scale: 
basis points) 

(Jan. 1993-Dec. 2020; left-hand scale: index, right-hand scale: 
basis points) 

Sources: Bloomberg Finance L.P. and ECB calculations. 
Notes: While the sample is limited and not every increase in the risk indicators was directly associated with monetary policy, a tighter 
policy stance might have impacted the scale of market volatility. Panel a: average values observed over the previous three hiking 
cycles. Option-adjusted spreads for ICE BofA Euro Corporate index. Panel b: average values observed over the previous four hiking 
cycles. Option-adjusted spreads for the Bloomberg US Corporate Bond index. 

The equity risk premium may be excessively compressed in the light of the 
weak macroeconomic outlook for the euro area. As the effects of monetary policy 
tightening transmit throughout the economy, a notable deterioration in growth 
prospects for the euro area is evident in economic forecasts and several leading 
indicators of economic activity (Chapter 1). Historically, the prospect of economic 
contraction has typically led to a substantial widening of risk premia as market 
participants demand higher compensation for taking risks in an environment in which 
corporate profits are expected to decline and default rates are expected to increase. 
In the past, this relationship has shown greater sensitivity for riskier assets. In recent 
months, however, risk premia in the euro area corporate bond market (Chart 2.6, 

21    Recently yield curve inversion has remained one of the few market indicators pointing to a large risk of 

recession. For further information, see the box entitled “The inversion of the yield curve and its 
information content in the euro area and the United States”, Economic Bulletin, Issue 7, ECB, 2023. 

22    See, for example, Blinder, A.S., “Landings, Soft and Hard: The Federal Reserve, 1965-2022”, Journal 

of Economic Perspectives, Vol. 37, No 1, Winter 2023, pp. 101-120. 

Financial Stability Review, November 2023 – Financial markets 

42 

5010015020025030035015202530354045-24-18-12-606121824Months around the end of ECB hikingcyclesVSTOXXCorporate bond spread (right-hand scale)75100125150175200101520253035-24-18-12-606121824Months around the end of Fed hiking cyclesVIXCorporate bond spread (right-hand scale) 
 
 
 
 
panel a) and equity market (Chart 2.6, panel b) have remained largely unchanged, 
despite a substantial decline in the composite Purchasing Managers’ Index (PMI) 
and its indications of economic contraction. Furthermore, although the level of risk 
premia in the corporate bond market still appears to be fairly well aligned with 
historical patterns, it is significantly compressed in the equity market. This will render 
equities vulnerable to abrupt repricing if the adverse effect of the economic 
slowdown on corporate profitability is greater than currently anticipated by investors. 

Chart 2.6 
The response of risk premia to the worsening growth outlook has so far been limited 

a) Risk premium in the euro area corporate 
bond market and Composite PMI 

b) Risk premium in the euro area equity 
market and Composite PMI 

(Jan. 2012-Oct. 2023; index, basis points) 

(Jan. 2012-Oct. 2023; index, percentages) 

Sources: Bloomberg Finance L.P., S&P Global Market Intelligence and ECB calculations. 
Notes: Composite PMI below 50 indicates economic contraction (red area) while above 50 indicates economic expansion (green area). 
The fitted lines are quadratic functions and exclude the first three months of pandemic-related lockdown (March-May 2020) as outliers. 
Panel a: credit risk premia are calculated as the option-adjusted spread for BBB-rated corporate bonds with a residual maturity of five 
to seven years. Panel b: equity risk premia are calculated as the five-year CAPE yield for the EURO STOXX less the five-year real 
(inflation-swap-adjusted) German government bond yield. 

China’s economic slowdown may also act as a drag on growth in the euro area 
and may adversely affect market sentiment. The reopening of the Chinese 
economy offered only temporary relief from concerns surrounding the local real 
estate market. Credit spreads for bonds issued by property developers spiked again 
to severely distressed levels as an increasing number of them found it difficult to 
meet their debt obligations (Chart 2.7, panel a). Furthermore, Chinese banks have 
seen their valuations plummet to historic lows, given that they hold vast majority of 
debt exposure to property developers. The substantial contribution made by the real 
estate sector to China’s GDP23  means that a downturn in the property market, 
coupled with subdued consumer confidence, could significantly impede overall 
economic growth in the country for an extended period. This risk would become even 
more pronounced if credit losses incurred by exposed banks led to a severe 
tightening of lending standards or, worse, a financial crisis also involving domestic 
shadow bank trusts. Although euro area entities have limited direct securities 

23    According to some studies, the contribution of the broad real estate sector to China’s GDP is estimated 
at almost 30%; see Rogoff, K. and Yang, Y., “Has China’s Housing Production Peaked?”, China & 
World Economy, Vol. 29, Issue 1, 2021, pp. 1-31. 

Financial Stability Review, November 2023 – Financial markets 

43 

0100200300400500404550556065Risk premiumComposite PMI2012-222023 year to dateOctober 20235678910111213404550556065Risk premiumComposite PMI2012-222023 year to dateOctober 2023 
 
 
 
 
exposure to Chinese companies, potential spillover effects could emerge due to 
China’s prominent role in the global economy. Macroeconomic shocks in China 
could therefore have a material impact on global financial markets.24  While the 
correlations between the Chinese equity market and markets in advanced 
economies weakened when inflation surged around the world, they have rebounded 
over the course of 2023 (Chart 2.7, panel b). For this reason, further negative 
surprises in China may have adverse effects on financial conditions in the euro area 
as well. 

Chart 2.7 
Vulnerabilities in China could spill over to advanced economies 

a) Spreads in the Chinese corporate bond 
market 

b) Equity market correlations between China 
and advanced economies 

(Jan. 2019-Nov. 2023, basis points) 

(Jan. 2019-Nov. 2023, percentages) 

Sources: Bloomberg Finance L.P. and ECB calculations. 
Notes: The latest observations are for 14 November 2023. Panel a: option-adjusted spreads for the ICE 1-5 Year USD China Senior 
Real Estate Corporate Constrained Index and the ICE BofA Asian Dollar High Yield Corporate China Issuers Index. Panel b: rolling 12-
month correlation for monthly returns on EURO STOXX (euro area), S&P 500 (United States) and MSCI China (China). 

2.3 

Rapid adoption of artificial intelligence might also have 
financial stability implications 

Progress in developing artificial intelligence has sparked euphoria among 
investors. Since May, the equity market in the United States has strongly 
outperformed that of the euro area, partly due to more positive macroeconomic 
surprises (Chart 2.8, panel a). However, robust economic data in the United States 
have also led investors to expect policy rates to remain higher for longer (Chart 2.1, 
panel b), contributing to the substantial increase in long-term nominal and real risk-
free rates. While the surge in these rates played a major role in the market correction 
in 2022, valuations of US companies have increased in 2023 despite the continued 
rise in real rates (Chart 2.8, panel b). This market rebound has been concentrated in 
the technology sector. As the shares of such high-growth companies are considered 

24    See, for example, the box entitled “The impact of Chinese macro risk shocks on global financial 

markets”, Financial Stability Review, ECB, May 2022. 

Financial Stability Review, November 2023 – Financial markets 

44 

01,0002,0003,0004,0005,0006,0007,00020192020202120222023Real estateHigh yieldDistressed level 02468101214-75-50-25025507510020192020202120222023China-euro area correlationChina-United States correlationGlobal CPI (right-hand scale) 
 
 
 
 
to be long-duration assets, their prices should be particularly sensitive to interest rate 
levels. Nevertheless, progress in adopting artificial intelligence (AI) has pushed 
equity valuations higher on the back of investors’ optimism about future earnings in 
companies judged likely to benefit from these new technologies. 

Chart 2.8 
Stronger economic outlook and AI advances have led US equity valuations higher 

a) Relative performance of equity markets and 
macroeconomic surprises in the United States 
and the euro area 

b) Valuation of the S&P 500 against long-term 
real risk-free rates 

(1 Jan.-14 Nov. 2023; left-hand scale: index spread, 
right-hand scale: index difference, 1 Jan. 2023 = 100) 

(Jan. 2015-Nov. 2023; left-hand scale: ratio, right-hand scale: 
percentages) 

Sources: Bloomberg Finance L.P. and ECB calculations. 
Notes: Panel a: “Economic surprise” shows the difference between the Citi Economic Surprise Index for the United States and for the 
euro area. “Equity performance” shows the normalised ratio of S&P 500 (United States) and EURO STOXX (euro area). Panel b: the 
latest observations are for 2 November 2023. Price to one-year blended-forward earnings and ten-year real (inflation-swap-adjusted) 
government bond yield. 

Potential overvaluation in the US equity market could have repercussions for 
financial markets in the euro area. Numerous equity valuation metrics in the 
United States reached decade-high levels during the summer, prompting concerns of 
overvaluation (Chart 2.9, panel a) or even an AI-related asset price bubble.25  By 
contrast, euro area equity valuation indicators did not increase to such levels (Chart 
2.9, panel a), partly because of the much smaller share of technology companies. 
Financial stability risks for the euro area from their potential overvaluation therefore 
relate mostly to spillovers from the United States. The deep integration of the two 
equity markets is evidenced by the very high correlation of returns, which typically 
becomes even stronger during periods of stress (Chart 2.9, panel b).26  Apart from 
real-economy linkages, these strong correlations might also stem from the level of 
similarity between the portfolios of global investors, which could have increased 
partly on account of the digitalisation of financial services (Box 3) and the growing 
share of passive investing. A disorderly correction in the US equity market could 
therefore affect euro area entities via large direct exposures, which amounted to €2.6 

25    Since June 2023 an AI/tech bubble has been consistently flagged by respondents to the Bank of 

America Global Fund Manager Survey as one of the biggest tail risks. 

26    See, for example, the box entitled “Risk of spillovers from US equity market corrections to euro area 

markets and financial conditions”, Financial Stability Review, ECB, May 2021. 

Financial Stability Review, November 2023 – Financial markets 

45 

92949698100102104106108110-200-150-100-5005010015020025001/2303/2305/2307/2309/2311/23Economic surprise: US vs EAEquity performance: US vs EA (right-hand scale)-2-101235913172125201520162017201820192020202120222023Forward P/EReal 10Y risk-free rate (right hand scale)ChatGPT launched 
 
 
 
 
trillion in the second quarter of 202327, and via the transmission of negative 
sentiment to euro area markets. 

Chart 2.9 
Potential overvaluation in the US equity market also poses a risk for euro area 
markets 

a) Equity market composite valuation metric 
relative to the ten-year average 

(Jan. 2021-Nov. 2023, z-scores) 

b) Volatility indices and correlations between 
equity markets in the euro area and the United 
States 

(Jan. 2019-Nov. 2023; left-hand scale: index, right-hand scale: 
percentages) 

Sources: Bloomberg Finance L.P. and ECB calculations. 
Notes: The latest observations are for 14 November 2023. Panel a: average z-scores of the following valuation metrics for EURO 
STOXX (euro area) and the S&P 500 (United States): price-to-book ratio, price-to-forward (twelve-month) earnings ratio, price-to-long-
term (ten-year) inflation-adjusted earnings ratio, price/earnings-to-growth ratio (growth rate calculated as the average of annualised 
five-year historical earnings growth and annualised two-year blended-forward earnings growth) and inverse risk premia proxied by five-
year CAPE yield less five-year real (inflation-swap-adjusted) government bond yield (German for the euro area). Panel b: VSTOXX 
and VIX are implied volatility indices based on options on the EURO STOXX 50 and on the S&P 500 respectively. Rolling 12-month 
correlation for monthly returns for EURO STOXX 50 and the S&P 500. 

The risk of technology-led asset price overvaluation warrants a thorough 
financial stability assessment. Concerns over a potential AI-related asset price 
bubble have prompted comparisons with the dotcom bubble. Research indicates that 
the dotcom crash did not have wider macroeconomic consequences.28  However, the 
companies around which bubble-type concerns are arising today are substantially 
larger in size.29  At the same time, the distribution of the most common equity 
valuation metrics was much more extreme at the peak of the dotcom bubble than is 
currently the case (Chart 2.10, panel a). Nevertheless, continuous monitoring is 
warranted, as systemic risk builds up when valuations are still increasing.30  Given 
the fact that credit-fuelled bubbles are often seen as more detrimental for financial 
stability, it is also crucial to assess how various forms of leverage and the associated 

27    Additional exposures might also stem from investments through financial intermediaries domiciled 

outside the euro area or via derivatives. 

28    See, for example, Brunnermeier, M., Rother, S. and Schnabel, I., “Asset Price Bubbles and Systemic 

Risk”, The Review of Financial Studies, Vol. 33, Issue 9, September 2020, pp. 4272-4317. 
29    During the dotcom bubble, the market capitalisation of companies from the Nasdaq-100 (which 

comprises the largest innovative non-financial corporations) relative to companies from the broader 
S&P 500 index grew over two years from 9.6% to 32.2% at the market peak. On 23 September 2023 
the ratio stood at 48.1%. 

30    Chen, G., Chen, L., Liu, Y. and Qu, Y., “Stock price bubbles, leverage and systemic risk”, International 

Review of Economics and Finance, Vol. 74, July 2021, pp. 404-417. 

Financial Stability Review, November 2023 – Financial markets 

46 

-1.5-1.0-0.50.00.51.01.501/2107/2101/2207/2201/2307/23Deviation from ten-year averageEuro areaUnited States025507510001530456020192020202120222023VSTOXXVIXCorrelation between equity returns (right-hand scale) 
 
 
 
 
risk of illiquidity spirals could affect financial institutions and broader financial 
markets. 

Chart 2.10 
Valuation metrics are below the extreme levels seen in the past but sensitivity to 
growth assumptions leaves the US equity market vulnerable to sudden repricing 

a) Distribution of P/E and P/B ratios for 
members of the NASDAQ 100 

b) P/E ratios for euro area and US sectors 
versus expected earnings growth rate 

(27 Mar. 2000, 14 Nov. 2023; ratios, percentages) 

(14 Nov. 2023; percentages, ratios) 

Sources: Bloomberg Finance L.P. and ECB calculations. 
Notes: The latest observations are for 14 November 2023. P/E stands for price-to-earnings; P/B stands for price-to-book. Panel a: 
share of total number of companies for which data on P/E and P/B ratios were available. Panel b: P/E ratios estimated for 2023. 
Annualised estimated earnings growth rate for the next two calendar years (2024 and 2025). The fitted lines are exponential functions 
based on values for EURO STOXX (euro area) and S&P 500 (United States) subindices for the following sectors: banks, consumer 
discretionary, consumer staples, energy, health care, industrials, technology and utilities. “US top 10” is based on the average values 
for the ten largest listed US companies, weighted by market capitalisation.   

The anticipation of high earnings growth related to AI adoption might lead to 
increased price volatility and the risk of a disorderly market correction. During 
the course of 2023, earnings expectations have increased substantially for 
companies expected to benefit most from AI adoption. Such expectations might be 
justified if AI significantly enhances productivity. At the same time, though, the non-
linear correlation between valuation metrics and earnings growth expectations 
(Chart 2.10, panel b) leaves the largest US companies vulnerable to sudden 
repricing. Elevated uncertainty surrounding the ultimate impact of AI could therefore 
also contribute to high volatility in the equity market, irrespective of whether the “AI 
rally” displays asset price bubble dynamics or not. 

The widespread adoption of AI, while offering many benefits, may also 
introduce new risks to market functioning. Market participants in the euro area 
are increasingly using AI in investment strategies, risk management, compliance, 
data analysis and post-trade processes.31  However, there are concerns around the 
potential manipulative use of AI, such as the ability to influence market sentiment 
through social media.32  The relevance of this risk transmission channel was 

31    See, for example, “Artificial intelligence in EU securities markets”, ESMA TRV Risk Analysis, ESMA, 1 

February 2023. 

32    See “ESMA Report on Trends, Risks and Vulnerabilities”, TRV Risk Monitor, No 2, ESMA, 31 August 

2023. 

Financial Stability Review, November 2023 – Financial markets 

47 

010203040506070(0,10](10,20](20,30](30,40](40,50](50,∞)EPS<0(0,2](2,4](4,6](6,8](8,10](10,∞)P/EP/BCurrentDotcom bubble peakNasdaq-100S&P 500EURO STOXXUS top 10010203040-10-50510152025P/E ratioExpected earnings growth rateEuro area sectorsUS sectors 
 
 
 
 
underscored in March 2023 when social media activity likely accelerated the failure 
of Silicon Valley Bank (Box 3).33  In addition, the proliferation of similar AI models in 
portfolio management could exacerbate herding behaviour and increase market 
procyclicality.34 

Box 3 
Financial stability considerations arising from the digitalisation of financial services 

Prepared by Katharina Cera, Allegra Pietsch and Andrzej Sowiński 

The digitalisation of financial services brings a variety of benefits but could also amplify and 
accelerate the materialisation of financial stability risks. The surge in retail investors 
participating directly in equity markets during the pandemic was associated with increased access 
to capital markets via trading apps (Chart A, panel a). This trend has certainly brought some 
benefits, for example by broadening risk sharing and lowering transaction costs. Nonetheless, 
authorities’ attention was drawn to episodes of extreme volatility in the prices of “meme” stocks35  in 
the first half of 2021, which had been induced by individual investors coordinating trades through 
social media.36  Furthermore, the banking sector stress in the United States in March 2023 reignited 
concerns around the impact of digitalisation on financial stability, as the interaction of increased 
online banking (Chart A, panel b) and social media may accelerate the pace of bank runs. 

The increased popularity of retail trading via apps, while bringing some benefits, could 
result in more procyclicality in financial markets. Digitalisation has made it easier for retail 
investors to trade in financial instruments not only by speeding up the opening of an investment 
account or the submission of trading orders, but also by providing widespread access to investment 
ideas published on social media. Making financial markets accessible to a broader range of 
investors is beneficial, as it enables risk sharing across the economy, provides more equal 
opportunities to gain financial returns and can help to deepen financial markets. At the same time, it 
can raise concerns about investor protection and market functioning. The new market participants 
are typically younger and less financially literate, and have a greater risk appetite, which has major 
implications for their trading behaviour.37  These investors might trade more frequently based on 
emotions or other non-fundamental factors. Such activity can be accentuated by trading platforms’ 
“social trading” functionality, which allows users to copy other investors’ trades automatically. 
Increased herding could, in turn, undermine the orderly functioning of financial markets by making 
asset price bubbles or disorderly corrections more likely. Moreover, the design of trading apps and 
their marketing campaigns have led to a “gamification of trading”, which might have attracted risk-
seeking individuals during the pandemic.38  Furthermore, excessive use of leverage via margin debt 

33    See, for example, “Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley 

Bank”, Board of Governors of the Federal Reserve System, 28 April 2023. 

34    See, for example, “Isaac Newton to AI”, remarks by Gary Gensler, SEC Chair, before the National 

Press Club, Washington, 17 July 2023. 

35    Stocks that became popular among retail investors via social media. 
36    See the box entitled “Retail Investors, Social Media, and Equity Trading”, Financial Stability Report, 

Board of Governors of the Federal Reserve System, November 2021, pp. 18-21. 

37    See “Final Report – On the European Commission mandate on certain aspects relating to retail 

investor protection”, ESMA, 29 April 2022. 

38    See, for example, Chiah, M. and Zhong, A., “Trading from home: The impact of COVID-19 on trading 
volume around the world”, Finance Research Letters, Vol. 37, November 2020, or Chiah, M., Tian, X. 
and Zhong, A., “Lockdown and retail trading in the equity market”, Journal of Behavioral and 
Experimental Finance, Vol. 33, March 2022. 

Financial Stability Review, November 2023 – Financial markets 

48 

 
 
 
(Chart A, panel c) or embedded in derivatives contracts such as 0 days to expiry (0DTE) options 
could potentially amplify market movements in tail events.39 

Chart A 
Digitalisation is progressing in both traditional banking and investment services 

a) Share of retail investors in the 
US equity trading volume and 
revenue of a leading mobile 
trading app provider 

b) Share of euro area and US 
population using online banking 

c) Share of retail investors in US 
equity market turnover and debit 
in US margin accounts 

(Q1 2019-Q2 2023; percentages, USD millions) 

(2010, 2022; percentages) 

(Jan. 2010-June 2023; percentages, USD billions) 

Sources: Bloomberg Finance L.P., Eurostat, FINRA, World Bank and ECB calculations. 
Notes: Panel a: revenue of an app provider refers to the revenue of Robinhood. Retail share refers to the share of retail investors in US equity market 
turnover. Panel b: “EA avg.” is the average of all countries shown weighted by population in 2010 and 2022. US data are only available for 2022. Structural 
breaks in the series mean that the change between 2010 and 2022 may be underestimated for Germany, Latvia and Luxembourg and overestimated for 
Estonia and Ireland. Panel c: the debit balance in a margin account is the amount of money a customer owes their broker for funds they have borrowed to 
purchase securities. 

Social media allows information to spread faster but can also trigger or amplify shocks. 
Social media has the potential to help retail investors make more informed and more timely 
decisions40, and to enable those bank depositors that are not protected by deposit insurance 
schemes to better understand financial risks. At the same time, it may foster herd behaviour while 
feeding rumours and disinformation, which could raise financial stability concerns. During the 
GameStop episode in 2021, retail investors coordinated on social media to buy the company’s 
heavily shorted stocks, resulting in some institutional investors facing a short squeeze which had a 
significant impact on market volatility (Chart B, panel a).41  The US bank tensions in March 2023 
raised concerns that negative sentiment on social media platforms could adversely affect banks’ 

39    See the box entitled “The Fast-Growing Interest in Retails’ Trading in the Zero-Day Options Market: Is It 
a Hidden Risk?’’, Global Financial Stability Report, International Monetary Fund, 11 April 2023, pp. 50-
51. 

40    See Farrell, M., Green, T.C., Jame, R. and Markov, S., “The democratization of investment research 
and the informativeness of retail investor trading”, Journal of Financial Economics, Vol. 145, Issue 2, 
Part B, August 2022. 

41    See, for example, Anand, A. and Pathak, J., “The role of Reddit in the GameStop short squeeze”, 

Economics Letters, Vol. 211, Issue C, February 2022, or Vasileiou, E., “Does the short squeeze lead to 
market abnormality and antileverage effect? Evidence from the GameStop case”, Journal of Economic 
Studies, Vol. 49, No 8, October 2022. 

Financial Stability Review, November 2023 – Financial markets 

49 

01002003004005006001416182022242603/1903/2003/2103/2203/23Retail shareRevenue (right-hand scale)020406080100FINLIEEELVBELTATLUESFRMTUSCYEA avg.HRPTSIDEITSK202220102003004005006007008009001,00051015202530Retail share in US equity market turnoverDebit in US margin accounts 
 
 
 
 
 
stock prices or fuel deposit outflows, as was likely the case with Silicon Valley Bank.42  For euro 
area banks, the correlation between sentiment on X, previously known as Twitter, and stock returns 
reached an all-time high of 64% in March 2023 (Chart B, panel b), though the nature of this 
relationship requires further investigation. At the same time, negative social media coverage was 
not associated with systematic deposit shifts between individual euro area banks during the March 
tensions. These events should not, however, be seen as a decisive test, given the lack of 
fundamental concerns about euro area banks at the time. 

Chart B 
Financial stability impact of social media tends to increase rapidly during periods of stress 

a) GameStop share price and Twitter coverage 

b) Twitter coverage and correlation with stock 
returns and deposit flows of euro area banks 

(1 June 2020-31 Dec. 2021; USD, thousands) 

(Jan. 2022-June 2023; correlation coefficient, negative tweets) 

Sources: Bloomberg Finance L.P., ECB (BSI) and ECB calculations. 
Notes: Panel a: the “Twitter Publication Count – Index” was established by scaling the publication count time series, capturing the number of tweets on a 
specific topic or security by a predefined list of selected influential accounts, by its maximum observation over the period shown. Panel b: based on a sample 
of 23 euro area listed significant institutions in the EURO STOXX Banks index. Deposit flows are monthly percentage changes of household and non-financial 
corporate deposits at the bank. Twitter sentiment data are normalised between 1 and -1 and indicate the average sentiment of tweets posted on individual 
banks. Stock returns are monthly price returns. Correlation is expressed as the monthly correlation coefficient for the cross-sectional data of bank-level Twitter 
sentiment and deposit movements or stock returns. “Negative tweets” captures the number of original negative tweets by a predefined list of selected 
influential accounts. Tweets are classified as “negative” from a long position investor perspective by Bloomberg’s supervised learning algorithm. 

The digitalisation of financial services may have broader policy-relevant implications for 
financial markets and banks. More retail investors are participating in financial markets thanks to 
digitalisation. Sometimes this might lead to excessive risk taking and undermine market integrity. In 
particular, additional monitoring of how leverage is used in financial products and extra scrutiny in 
market abuse supervision are both warranted. The case of Silicon Valley Bank represents the most 
prominent bank run of the digital era. Few depositors queued up outside a branch – instead they 
used bank apps and phone calls to access their money within minutes.43  Accordingly, regulators 
and supervisors should consider the issue of how digitalisation could accelerate the pace of deposit 

42    Communication via social media likely accelerated the failure of Silicon Valley Bank which faced 

fundamental issues due to the materialisation of unrealised losses. A highly concentrated depositor 
base with a large share of uninsured deposits may have made it particularly vulnerable to coordinated 
deposit outflows. See “Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley 
Bank”, Board of Governors of the Federal Reserve System, 28 April 2023. See also Cookson, J.A., 
Fox, C., Gil-Bazo, J., Imbet, J.F. and Schiller, C., “Social Media as a Bank Run Catalyst”, Université 
Paris-Dauphine Research Paper, No 4422754, 13 July 2023. 

43    In contrast to physical branches, online banking services are available 24/7 except during periods of 

scheduled maintenance. 

Financial Stability Review, November 2023 – Financial markets 

50 

10203040506002040608010006/2009/2012/2003/2106/2109/2112/21GameStop share priceVIX (right-hand scale)Twitter Publication Count -Index0200400600800100012001400-0.6-0.4-0.20.00.20.40.60.801/2204/2207/2210/2201/2304/23Correlation between Twitter sentiment and stock returnCorrelation between Twitter sentiment and deposit growth rateNegative tweets (right-hand scale) 
 
 
 
 
withdrawals in a structural way during periods of stress.44  This could encourage the collection of 
deposit data at a higher frequency. Finally, how social media activities relate to financial stability 
concerns and how the analysis of such activities can be used to monitor risks requires further 
investigation. 

44    See McCaul, E., “Mind the gap: we need better oversight of crypto activities”, blog post, ECB, April 
2023, and Bindseil, U. and Senner, R., “Destabilisation of Bank Deposits Across Destinations – 
Assessment and Policy Implications”, SSRN, 15 September 2023. 

Financial Stability Review, November 2023 – Financial markets 

51 

 
 
 
 
3 

Euro area banking sector 

3.1 

Profitability at multi-year heights, but headwinds grow 

The widening of interest margins has continued to boost the profitability of 
euro area banks to record levels. The four-quarter trailing return on equity (ROE) 
of euro area significant institutions has gone on rising in 2023 and reached 8.9% in 

Financial Stability Review, November 2023 – Euro area banking sector 

52 

Sharp decline in lending growthFurther uptick in payment arrears possible Persistent gap between COE and ROERising cost of deposit fundingECB policy rate and deposit rates• Further uptick in payment arrears possible• Sharp decline in lending growth• Rising cost of deposit funding• Persistent gap between COE and ROEHeadwinds to bank profitability as asset quality concerns and funding costs riseCost of equity and return on equity over timeRatio of loans <90d past dueAnnual growth rateof lending to NFCs and HHs0.470.251.100.88Q3 19Q2 23Consumer loansCRE loans024681012141612/1902/23COEROE48121620ROE projections2024E2023E4.001.030.75Policy rateNFCdepositsHHdeposits024681001/2209/23Lendingto NFCsLendingto HHs 
 
 
the second quarter, a level last seen 15 years ago (Chart 3.1, panel a).45  The 
improvements in ROE seen since the end of 2022 have been driven mostly by higher 
net interest income (NII) (Chart 3.1, panel b). While higher lending volumes were the 
main driver of NII growth in the first quarter, margin expansion was the key factor 
behind improved NII levels in the second quarter. In some countries, such as France 
and Germany, other operating profits relating to trading activities accounted for the 
bulk of the changes in ROE. Third quarter earnings releases of listed banks suggest 
that the profitability of euro area banks remained almost unchanged. 

Chart 3.1 
Bank profitability has reached levels last seen 15 years ago, on the back of rising net 
interest income 

a) ROE, COE and market 
valuation of euro area banks 

b) Decomposition of changes in significant institutions’ ROE, 
operating profits and net interest income 

(Q1 2001-Q2 2023, percentages) 

(Q3 2022-Q2 2023, percentages, percentage points) 

Sources: Bloomberg Finance L.P., ECB (supervisory data) and ECB calculations. 
Notes: Panel a: ROE and price-to-book ratio are calculated on the basis of a balanced sample of 19 euro area banks. COE stands for 
cost of equity. Altavilla et al.* estimate the COE of euro area banks as an average across ten different models (five implied COE 
models and five factor models), which are estimated for individual listed euro area banks and then weighted by market capitalisation. 
Panel b: based on a balanced sample of 81 euro area significant institutions. NFCI stands for net fee and commission income. 
*) Altavilla, C., Bochmann, P., De Ryck, J., Dumitru, A., Grodzicki, M., Kick, H., Melo Fernandes, C., Mosthaf, J., O’Donnell, C. and 
Palligkinis, S., “Measuring the cost of equity of euro area banks”, Occasional Paper Series, No 254, ECB, 2021. 

Differences in pass-through of policy rates explain most of the dispersion of 
interest margins across euro area countries. Interest margins have taken 
different paths across loan segments and euro area countries since the start of the 
hiking cycle last year. While total net interest margins (NIMs) have remained below 
pre-pandemic levels for the euro area overall, the NIM for corporate lending climbed 
to new heights as loans to non-financial corporations (NFCs) are granted 
predominantly at variable rates. By contrast, aggregate NIMs for lending to 
households continued to decline for the euro area, which illustrates the implications 
for bank profitability of mortgage lending at fixed interest rates during the period of 

45    The Financial Stability Review uses the four-quarter average of stock variables, while flow variables are 
annualised using trailing four-quarter sums. In addition, a balanced sample of banks is used to avoid 
composition effects, which might result in figures that differ from those in the published Supervisory 
Banking Statistics. The ROE in the text refers to a balanced sample of 81 banks using supervisory 
data, while Chart 3.1, panel a) shows the ROE based on Bloomberg data to capture a longer sample. 

Financial Stability Review, November 2023 – Euro area banking sector 

53 

0.00.51.01.52.02.5-505101520200120052009201320172021Return on equityCost of equityPrice-to-book ratio (right-hand scale)-3-2-1012345ROE changeTotal equityImpairmentsOp. profitsOther P&LROE-10-50510152025303540Operating profitchangeNIINFCIOtherExpensesOp. profits-5051015202530NII changeMargin effectVolume effectNet interest income 
 
 
 
 
ultra-low interest rates (Chart 3.2, panel a). Indeed, the share of variable-rate 
lending and the sensitivity of deposit rates to ECB policy rates (the “deposit beta”) 
are two major factors explaining the margin differences across euro area countries 
(Chart 3.2, panel b). 

Chart 3.2 
Margin expansion was driven largely by corporate lending, and the share of variable-
rate lending and deposit betas explain NIM dispersion across countries 

a) Change in total NIM of euro area banks and 
NIM for lending to households and NFCs 

b) Share of variable-rate lending and deposit 
betas vs NIM across euro area countries 

(Q1 2019-Q2 2023, percentages) 

(Q2 2023, percentages) 

Sources: ECB (supervisory data, BSI, MIR) and ECB calculations. 
Notes: Based on a balanced sample of 81 euro area significant institutions. Panel a: all measures of NIM shown refer to the 
outstanding stock. The NIM for households (HH) and non-financial corporations (NFCs) refers to banks’ lending activities. Panel b: 
deposit betas capture the percentage pass-through of the increase in the ECB’s deposit facility rate to new business deposit rates 
since the start of the hiking cycle in July 2022. 

Looking forward, downside risks are growing for banks on the back of asset 
quality concerns, muted lending dynamics and rising funding costs. While 
banks have so far largely benefited from higher interest rates, going forward their 
profits are likely to be constrained by three factors. First, the combination of higher 
living costs, higher debt service costs and a deteriorating macroeconomic 
environment could eventually have an adverse impact on bank asset quality. 
Second, higher lending rates, lower loan demand and tighter credit standards have 
led to a substantial drop in lending volumes, which will weigh on bank profitability. 
Finally, compared with past hiking cycles, the pass-through of rate hikes to 
depositors has been more limited for overnight deposits, partly due to the ample 
level of excess liquidity in the system and the abundance of overnight deposits 
without regulatory value for banks. Banks’ currently strong profitability is likely to 
come under pressure as their funding costs catch up with the interest rates paid on 
new business and their funding composition continues to shift towards more 
expensive sources. Indeed, market analysts expect ROE to decline slightly by 2024 
(Chart 3.3, panel a); moreover, these expectations may be skewed to the upside as 
they are founded on benign projections of asset quality. Profitability is projected to 
decline in most countries going forward. At the same time, ROE is expected to 
improve in some countries, especially those with a higher share of fixed-rate lending 

Financial Stability Review, November 2023 – Euro area banking sector 

54 

1.01.21.41.61.82.02.22.42.62.83.020192020202120222023NIMNIM HH lendingNIM NFC lendingEA0.81.01.21.41.61.82.02.22.42.62.83.0406080100Net interest marginVariable-rate shareEA0.81.01.21.41.61.82.02.22.42.62.83.00102030Deposit betaNet interest margin 
 
 
 
where loan repricing takes place more gradually and which have already seen a 
larger pass-through of rate hikes to depositors (Chart 3.3, panel b). 

Chart 3.3 
Profitability projections for the next two years are below those for 2023, reflecting 
headwinds related to asset quality concerns, muted lending and rising funding costs 

a) Change in ROE projections for euro area 
banks 

b) ROE projections for euro area banks 
across countries 

(1 Jan.-14 Nov. 2023, percentages) 

(14 Nov. 2023, percentages) 

Sources: LSEG and ECB calculations. 
Note: Based on market analyst projections of ROE for a sample of 29 listed euro area banks. 

3.2 

Early signs of asset quality deterioration from historical 
lows 

The asset quality of euro area banks remains robust, but default rates and 
payment arrears are showing early signs of stress. Banks’ aggregate non-
performing loan (NPL) ratio, a lagging indicator of asset quality, remained close to 
historical lows in the second quarter of 2023, while the Stage 2 ratio has declined 
slightly from recent elevated levels (Chart 3.4, panel a, left graph). At the same time, 
default rates on both corporate and retail exposures have started to increase (Chart 
3.4, panel a, right graph), and the share of loans which are less than 90 days past 
due but still performing has also picked up and stands above the historically low 
levels seen in 2022. This increase may translate into more NPLs in the coming 
quarters, as new NPL formation typically lags any rise in early payment arrears 
(Chart 3.4, panel b). 

Financial Stability Review, November 2023 – Euro area banking sector 

55 

8.08.59.09.510.010.511.011.501/2303/2305/2307/2309/2311/2320232024202567891011121314151617FIBEATGRPTNLITESFRDE202320242025 
 
 
 
Chart 3.4 
NPL ratio remains stable, while default rates and payment arrears increase from low 
levels 

a) NPL and Stage 2 ratios for total loans; euro area default 
rates on corporate and retail exposures 

b) Share of NFC loans that are 
less than one year past due 

(left graph: Q1 2018-Q2 2023, percentages; 
right graph: Q4 2018-Q2 2023, percentages) 

(Q1 2019-Q2 2023, percentages) 

Source: ECB (supervisory data). 
Notes: Panel a, left graph: based on a balanced sample of 81 euro area significant institutions; right graph: IRB-reporting significant 
institutions. Four-quarter trailing figures. Euro area exposures only. Panel b: full sample of significant institutions. 

After a long period of improving asset quality, early signs of strain are now 
evident across loan portfolios. A breakdown by firm size reveals some divergence 
in asset quality as NPL ratios on loans to smaller firms46  increased over the last two 
quarters, while NPL ratios decreased slightly on loans to firms with relatively higher 
total assets (top 5% of firms by total assets) (Chart 3.5, panel a, left graph). This 
development is in line with the typically stronger sensitivity of small firms to economic 
activity. Gross NPL inflows for loans to the commercial real estate (CRE) sector47,48 
increased more in the second quarter of 2023 than offsetting NPL outflows (Chart 
3.5, panel a, right graph). Given the recent substantial increase in interest rates, 
mortgages in countries with high shares of variable rates were more likely to become 
non-performing (Chart 3.5, panel b, left graph). Similarly, consumer loans saw their 
first couple of quarters of net NPL inflows after a long period of outflows (Chart 3.5, 
panel b, right graph). Countries with predominantly variable rates would be likely to 
see a more pronounced deterioration in asset quality going forward if the labour 
market were to weaken notably, adding to the squeeze on households due to rising 
mortgage debt service costs and a higher cost of living (Special Feature B). 

46    Smaller firms are defined as the bottom 95% of firms by total assets. Loans to this group of firms 

represent 25% of corporate exposures. 

47    The share of CRE loans in total loans varies widely across banks, however, with an interquartile range 

of between 4.8% and 16.2%. 

48    For loans other than those held for sale and trading. 

Financial Stability Review, November 2023 – Euro area banking sector 

56 

0.00.40.81.21.62.02.42.83.23.64.04.44.80.00.20.40.60.81.01.21.41.61.82.02.22.4Q4 2018Q2 2019Q4 2019Q2 2020Q4 2020Q2 2021Q4 2021Q2 2022Q4 2022Q2 2023EA corporate -totalEA corporate -SME (right-hand scale)EA retail -totalEA retail -qualifying revolvingEA retail -other non-SME024681012Q1 2018Q3 2018Q1 2019Q3 2019Q1 2020Q3 2020Q1 2021Q3 2021Q1 2022Q3 2022Q1 2023NPL ratioStage 2 ratio0.00.10.20.30.40.50.6Q1 2019Q3 2019Q1 2020Q3 2020Q1 2021Q3 2021Q1 2022Q3 2022Q1 2023Past due 30-90 days (performing)Past due 90-180 days (NPL)Past due 180 days-1 year (NPL) 
 
 
 
 
Chart 3.5 
Recent increase in mortgage NPL ratios predominantly in variable-rate countries; 
slight rise in CRE and consumer loans with recent NPL net inflows and NPL ratio of 
smaller firms up slightly 

a) NPL ratio, by firm size; quarterly NPL flows 
for CRE loans 

b) Share of variable-rate mortgage lending 
and change in mortgage NPL ratios across 
euro area countries; quarterly NPL flows for 
consumer loans 

(left graph: Q1 2022-Q2 2023, exposure-weighted NPL ratio for 
NFC loans, percentages; right graph: Q3 2020-Q2 2023, 
€ billions) 

(left graph: x-axis: 2009-23 mean, percentages; y-axis: difference 
between Q1 2023 and Q2 2023, percentage points; right graph: 
Q3 2020-Q2 2023, € billions) 

Sources: ECB (AnaCredit, MIR, RIAD, supervisory data), BvD Electronic Publishing GmbH – a Moody’s Analytics company and ECB 
calculations. 
Notes: Panel a, left graph: only significant institutions supervised by the ECB. Total assets are taken from Orbis as at December 2021. 
The top 5% firms in terms of total assets are responsible for, on average, 75% of the outstanding amount of loans. Panels a and b, 
right graphs: full sample of significant institutions. Excludes loans held for sale. Panel b, left graph: the mean from 2009 to 2022 serves 
as a proxy for the share of variable-rate mortgages in the outstanding stock of loans in a given country. Fixed-rate mortgages are 
defined as new mortgages with fixed rates and maturities of more than one year/all new mortgages at a monthly frequency. The 
change in the mortgage NPL ratio is aggregated at the lender country level and covers the full sample of significant institutions. The 
data for Greece, Cyprus and Luxembourg are not shown in the graph due to the relatively large absolute changes in their respective 
mortgage NPL ratios. Their addition would not materially change the relationship shown when accounting for the size of the respective 
mortgage loan portfolios. Some national authorities have country-specific data on fixation periods of the stocks, but differences 
between the national data and the approximation based on flows are not substantial in most cases. Some differences can be seen, 
however, for Italy. 

Banks may face higher provisioning needs, reflecting the vulnerability of 
borrowers to higher interest rates. The NPL coverage ratios of most loan 
portfolios have fallen compared with longer-term averages, in particular for consumer 
loans (Chart 3.6, panel a). The decline for collateralised loans may be explained at 
least in part by the fact that asset prices still stand above pre-pandemic levels, but 
with real estate collateral becoming increasingly illiquid and property prices falling, 
there is a risk that banks may be slow in adjusting their expected recoveries to 
reality, thereby potentially understating provisions. Banks recently increased 
provisions on loans to firms with lower interest coverage ratios (ICRs), meaning they 
are less able to repay their debt out of their recurring cash flows (Chart 3.6, panel b). 
This stands in contrast with the slight decline in provisions for high-ICR firms while 
remaining consistent with the notion that banks are anticipating stress for firms which 
are especially vulnerable to the recent rise in interest rates. The flipside of this is 
higher bank profitability for the time being. Nonetheless, a longer period of high 
interest rates is likely to lead to higher provisions, which in turn will be a drag on 
profitability further down the line. On the one hand, the difference in provisioning is 

Financial Stability Review, November 2023 – Euro area banking sector 

57 

-20-15-10-5051015Q3 2020Q1 2021Q3 2021Q1 2022Q3 2022Q1 2023InflowsOutflowsNet flows1.52.02.53.03.54.04.5Q1 2022Q2 2022Q3 2022Q1 2023Q2 2023Bottom 95% (smaller firms)Top 5% (larger firms)-20-15-10-5051015Q3 2020Q1 2021Q3 2021Q1 2022Q3 2022Q1 2023InflowsOutflowsNet flowsFRBEDENLITESIEATSIMTPTEELVFI-0.25-0.20-0.15-0.10-0.050.000.050.100.150.200.25050100 
 
 
 
reassuring because banks appear to be aware of the risk. On the other hand, it 
shows their exposure to this risk. 

Chart 3.6 
NPL coverage ratios remain below long-term averages, and banks are provisioning 
more for firms vulnerable to interest rate increases (low ICR) 

a) NPL coverage ratios 

b) Provisioning, by ICR 

(Q2 2023, 2014-22 average; percentages) 

(Q1 2022-Q1 2023, percentages) 

Source: ECB (supervisory data). 
Notes: Full sample of significant institutions. Panel a: CONS stands for consumer loans. Panel b: provisions as a share of exposures 
for all non-defaulted NFC loans. 

Lending dynamics have weakened substantially, which will weigh on bank 
profitability going forward. The monetary policy tightening that started last year 
prompted banks to tighten their credit standards to historically elevated levels. In 
addition, higher interest rates, coupled with a more uncertain economic outlook, have 
contributed to a substantial decline in loan demand (Chart 3.7, panel a). As a 
consequence, cumulative year-to-date net lending flows to the non-financial private 
sector have been stagnant, in stark contrast with the loan book expansion seen over 
the previous seven years (Chart 3.7, panel b). While banks’ lending margins have 
expanded on the back of higher rates, the muted lending dynamics represent a 
headwind for bank profitability going forward. 

Financial Stability Review, November 2023 – Euro area banking sector 

58 

010203040506070Total loansNFC totalSMECREHH totalRRECONSQ2 2023Long-term average0.20.30.40.50.60.70.80.91.0Q1 2022Q2 2022Q3 2022Q42022Q1 20231st quartile (low ICR)4th quartile (high ICR) 
 
 
 
Chart 3.7 
Credit standards have tightened and loan demand has declined to historical lows, 
while year-to-date lending flows are the lowest since 2015 

a) Credit standards and loan demand for 
lending to NFCs and household mortgages 

b) Year-to-date flows of lending to NFCs and 
households 

(Q1 2003-Q3 2023, net percentages) 

(2003-23, € billions) 

Sources: ECB (BLS, BSI) and ECB calculations. 
Notes: Panel a: for credit standards, net percentages are defined as the difference between the sum of the shares of banks 
responding “tightened considerably” and “tightened somewhat” and the sum of the percentages of banks responding “eased 
somewhat” and “eased considerably” in the ECB’s bank lending survey. Net percentages for the questions on demand for loans are 
defined as the difference between the sum of the shares of banks responding “increased considerably” and “increased somewhat” and 
the sum of the shares of banks responding “decreased somewhat” and “decreased considerably”. 

3.3 

Rising funding costs as bonds reprice and deposit betas 
adjust 

The pass-through of policy rates to depositors by euro area banks remains 
limited for overnight deposits, leading to a shift towards term deposits. The 
pass-through of policy rates to bank depositors has not substantially changed since 
the publication of the previous Financial Stability Review and remains sizeable only 
for term deposits (Chart 3.8, panel a, left graph). After years of low rates, banks’ 
deposit books have been skewed towards overnight deposits. But while overnight 
deposits are constantly repriced at the prevailing rates, banks have been reluctant to 
increase these overnight rates more substantially. At 0.3% and 0.7% respectively, 
interest rates on overnight deposits from households and from NFCs, which account 
for the largest share of outstanding deposit volumes in both segments, correspond 
only to a pass-through rate of 7% and 18% of the change in policy rates since 
summer last year. These deposit betas are low compared with past hiking cycles, 
making it likely that a more substantial rise in deposit rates will weigh on interest 
margins, and hence bank profitability, going forward. There is a substantial 
dispersion of deposit betas across not only different types of deposit and 
counterparty but also euro area countries, which is to some extent driven by 
regulation as well as by competition among banks (Chart 3.8, panel a, right graph). 
The differences in remuneration between deposit types has led to a gradual shift 
from overnight to term deposits since the start of the hiking cycle, in line with 

Financial Stability Review, November 2023 – Euro area banking sector 

59 

-80-60-40-200204060802003200620092012201520182021Credit standards, NFCsCredit standards, HH mortgagesLoan demand, NFCsLoan demand, HH mortgages-200-10001002003004005006007002003200620092012201520182021HH consumer lending flowsHH mortgage lending flowsNFC lending flows adjusted 
 
 
 
historical regularities, and funds have remained largely within the banking sector 
(Chart 3.8, panel b). The fact that deposit outflows have been higher than inflows 
into money market funds in absolute terms could be related to higher consumption 
and working capital costs in a context of higher inflation. Concerns about deposit 
outflows have also been mentioned in the discussions surrounding the introduction 
of a digital euro. Specific design features such as a cap on individual holdings would 
prevent such unintended consequences (Box 4). 

Chart 3.8 
Depositors are slowly shifting from overnight accounts to better-remunerated term 
deposits 

a) Change in aggregate deposit rates since 
start of tightening cycle; deposit betas across 
euro area countries 

b) Cumulative flows of bank deposits, money 
market funds and bonds 

(left graph: Jan. 2022-Nov. 2023, percentages; 
right graph: Sep. 2023, percentages) 

(Sep. 2022-Sep. 2023, € billions) 

Sources: ECB (BSI, MIR) and ECB calculations. 
Notes: Panel a: deposit betas capture the percentage pass-through of the increase in the ECB’s deposit facility rate (DFR) to new 
business deposit rates since the start of the hiking cycle in July 2022. All three deposit types – overnight, notice and term deposits – 
are taken into account in the right graph. Panel b: bank deposits consist of deposits placed with the monetary financial institution (MFI) 
sector by euro area residents excluding MFIs, central governments and financial vehicle corporations involved in securitisation activity. 
Their flows have been adjusted for the operational incident in TARGET2, which inflated the September 2022 other financial institutions 
deposits before then being reversed in October and November 2022. Bank bonds are those held by euro area residents excluding 
MFIs and central governments. 

Bond issuance volumes have been very strong this year, in particular for 
senior instruments, despite elevated funding costs. The yields on euro area 
bank bonds have stabilised at elevated levels since late spring (Chart 3.9, panel a). 
As a sizeable share of bank bonds matures over the next few years, the large 
increase in bond yields since the end of 2021 will continue to translate into higher 
bond funding costs for banks. A repricing of maturing bonds at current secondary 
market yields would cause banks’ bond funding costs to rise to 2.1% at the end of 
2023 and 2.4% at the end of 2025. Apart from March, when bond issuance stalled 
due to the tensions in the Swiss and US banking sectors, 2023 has seen issuance 
volumes well above the range observed prior to the pandemic (Chart 3.9, panel b, 
left graph). At €432 billion, year-to-date issuance volumes are around 37% above the 
average observed between 2017 and 2019. Issuance of covered and senior 

Financial Stability Review, November 2023 – Euro area banking sector 

60 

-1.0-0.50.00.51.01.52.02.53.03.54.04.501/2207/2201/2307/23DFRHH overnightHH noticeHH termNFC overnightNFC term010203040CYMTGRSIIEESPTSKLTITLVBEEADEEEATFIFRLUNLTotalHHNFC-1,200-1,000-800-600-400-20002004006008001,0001,20009/2211/2201/2303/2305/2307/2309/23Total depositsMoney market fundsOvernight depositsOther depositsTime depositsBank bonds 
 
 
 
unsecured bonds has been particularly strong in 2023, while that of senior bail-inable 
bonds has remained below pre-pandemic averages (Chart 3.9, panel b, right graph). 
The market for Additional Tier 1 securities has reopened gradually as spreads 
narrowed from the levels observed immediately after the March tensions. Banks 
have also shortened bond maturities quite substantially in response to higher interest 
rates. While the aggregate maturity of outstanding senior bonds for euro area banks 
is around ten years, senior bonds issued in 2023 only have an average maturity of 
around six years. 

Chart 3.9 
Bond yields have remained broadly unchanged at elevated levels, while issuance 
activity is strong, especially for covered and senior unsecured instruments 

a) Bond yields of euro area banks across 
seniorities and average bond funding costs 

b) Monthly and year-to-date bond issuance 
volumes of euro area banks 

(Q4 2021-2025E, annual percentages) 

(€ billions) 

Sources: S&P Dow Jones Indices LLC and/or its affiliates, Dealogic and ECB calculations. 
Notes: Panel a: the funding cost scenario (indicated by the dotted line) assumes that maturing bonds are refinanced at a yield to 
maturity observed in the secondary market in September. All funding costs are volume weighted (covered, senior unsecured, 
NPS/HoldCo and T2 bonds are included, being the main seniorities maturing in 2023). AT1 stands for Additional Tier 1 securities; T2 
stands for Tier 2 securities; NPS/HoldCo stands for senior non-preferred securities. 

Liquidity buffers remain well above regulatory requirements, despite declining 
upon repayment of central bank funding. Aggregate liquidity ratios of euro area 
banks continued their expected decline in line with the gradual repayment of the 
targeted longer-term refinancing operations (TLTRO) and the associated, albeit 
smaller, reduction in central bank reserves. Central bank reserves were also affected 
by autonomous factors, with a significant amount of non-monetary policy deposits 
moving away from the Eurosystem into the market. The aggregate liquidity coverage 
ratio (LCR) fell from a peak of 174% in the second quarter of 2021 to 157% in the 
second quarter of 2023, while the net stable funding ratio (NSFR) – which captures 
the medium-term resilience of bank funding – has increased slightly during the past 
six months to 125% (Chart 3.10, panel a). In terms of the breakdown of high-quality 
liquid assets, the share of central bank reserves has declined alongside TLTRO 
repayments but remains the largest single element, at around two-thirds of the total. 
The aggregate picture masks substantial differences at the individual bank level. 

Financial Stability Review, November 2023 – Euro area banking sector 

61 

0246810121412/2103/2206/2209/2212/2203/2306/2309/232023E2024E2025ECoveredSenior unsecuredNPS/HoldCoT2AT1Average bond funding costs02040608010012013579112017-19 range20222023020406080100120140160180200CoveredSeniorunsecuredNPS/HoldCoT2AT12017-19 range20222023 
 
 
 
While the vast majority of significant institutions have liquidity ratios well above their 
regulatory requirements, there are some banks with LCR and NSFR levels that 
indicate lower resilience to funding stress. Large banks tend to operate with smaller 
liquidity buffers, which is evident from the fact that the 25th percentile for both 
liquidity ratios is close to the euro area aggregate (Chart 3.10, panel b). 

Chart 3.10 
Despite gradual TLTRO repayments, liquidity ratios are substantially above 
regulatory thresholds overall, but some banks have smaller liquidity buffers 

a) High-quality liquid assets and liquidity 
ratios; cumulative changes in TLTROs of euro 
area banks 

b) Dispersion of liquidity ratios across euro 
area banks 

(left graph: Q1 2017-Q2 2023, € trillions, percentages; 
right graph: June 2022-Oct. 2023, € trillions) 

(Q2 2021, Q2 2023, percentages) 

Sources: ECB (supervisory data, ILM) and ECB calculations. 
Notes: Based on a balanced sample of 81 euro area significant institutions. Panel b: the dashed and the dotted yellow lines represent 
the median and the 25th percentile for the cross-sectional distribution of the LCR and NSFR in Q2 2023 respectively. 

Box 4 
A digital euro: gauging the financial stability implications 

Prepared by Claudia Lambert, Cosimo Pancaro and Antonella Pellicani 

Central banks around the world have stepped up their efforts to explore and develop their 
own digital currencies (known as CBDCs),49  an electronic equivalent to cash. New 
technologies in retail payments (e.g. mobile payments, digital wallets and the potential future 
deployment of crypto-asset payments) and changes in people’s payment habits have fuelled the 
interest of central banks in CBDCs. In the euro area, for example, the share of transactions for 
which cash was used as a means of payment declined from 79% to 59% between 2016 and 2022. 
At the same time, the coronavirus (COVID-19) pandemic, among other things, has accelerated the 
shift towards online shopping and digital payments (Chart A, panel a). In response, central banks 

49    A CBDC is a digital form of central bank money that would be available to the general public as a 

complement to banknotes and coins. The ECB is currently working with the euro area national central 
banks to investigate whether to introduce a CBDC in the euro area. For more information, see the 
digital euro page on the ECB’s website. 

Financial Stability Review, November 2023 – Euro area banking sector 

62 

120130140150160170180012345201720202023Central bank reservesGovernment bondsOtherLCR (right-hand scale)NSFR (right-hand scale)-1.8-1.6-1.4-1.2-1.0-0.8-0.6-0.4-0.20.00.206/2209/2212/2203/2306/2309/23100110120130140150160170180190200100200300400NSFRLCRQ2 2021Q2 2023 
 
 
 
 
are investigating the benefits and risks of CBDCs in complementing banknotes and coins, offering 
an additional means of payment in an increasingly digitalised economy (Chart A, panel b). 

Chart A   
The role of cash as a means of payment has been declining in the euro area over the last few 
years, while CBDC-related projects around the world are thriving 

a) Share of transactions in the euro area, by means 
of payment 

b) Retail CBDC status 

(percentages) 

Sources: Panel a: ECB (SPACE). Panel b: cbdctracker.org. 
Notes: Panel a: “Other” includes bank cheques, credit transfers, loyalty points, vouchers and gift cards, and other payment instruments. Percentages may not 
add up to 100% due to rounding. Panel b: retail CBDC refers to digital central bank money offered to the general public, while wholesale CBDC refers to the 
settlement of interbank transfers and related wholesale transactions in central bank reserves. The map shows the status of retail CBDC initiatives as of 1 
September 2023. 

In the euro area, the introduction of a CBDC (“digital euro”) could offer several financial 
stability benefits by providing an alternative to new forms of private digital money and 
spurring innovation. Recent years have seen a significant increase in the number of non-
European big-techs50  active in the European payments landscape as well as a proliferation of 
crypto-assets and stablecoins.51  A digital euro would help to preserve the role of public money as 
the anchor for the monetary system in the digital age and protect monetary sovereignty. The 
introduction of a digital euro could also stimulate innovation,52  which may benefit banks and non-
bank entities, and promote a more competitive, efficient and resilient financial system (Chart B, 
panel a). 

50    See, for example, Beck, T. et al., “Will video kill the radio star? Digitalisation and the future of banking”, 

Reports of the Advisory Scientific Committee, No 12, ESRB, 2022. 

51    See, for example, the article entitled “Stablecoins’ role in crypto an beyond: functions, risks and policy”, 
Macroprudential Bulletin, ECB, July 2022, and the box entitled “The expanding uses and functions of 
stablecoins”, Financial Stability Review, ECB, November 2021. 

52    For example, a CBDC has the potential to streamline payment processes and reduce transaction costs. 
Moreover, a CBDC could potentially enhance cross-border transactions by simplifying the settlement 
process. 

Financial Stability Review, November 2023 – Euro area banking sector 

63 

79545942193934463427380102030405060708090100TotalValueTotalValue20162022CashCardsMobile appsOtherCancelledLaunchedPilotProofof conceptResearch 
 
 
 
 
Chart B   
A digital euro could offer financial stability benefits but, if not properly designed, could also prompt 
financial stability risks 

a) Digital euro benefits and risks 

b) Simulated impact on key liquidity indicators 

(x-axis: deposit outflows, percentages; y-axis: liquidity indicators, 
percentages) 

Sources: Panel b: ECB (supervisory data) and ECB calculations. 
Notes: Panel b: simulated impact on key liquidity indicators in a scenario in which banks are willing to draw down their entire voluntary liquidity buffers up to 
the regulatory minimum (100% for the NSFR and the LCR) to meet the demand for digital euro. The simulation is based on Q1 2023 data. The liquidity 
indicators represent averages across 111 significant institutions, weighted by total assets. The 0% deposit outflow scenario represents the liquidity metrics in 
the absence of a digital euro. The other scenarios show how the conversion of household overnight deposits into digital euro, ranging between 5% and 30%, 
impacts the liquidity metrics: the blue and yellow bars. The green box indicates the range and upper bound of potential levels of household overnight deposit 
outflows in the event of a €3,000 holding limit per person. 

At the same time, a CBDC, if not properly designed, could prompt financial stability risks 
and affect the structure and scale of bank intermediation. The introduction of a CBDC could 
lead to changes in the demand for bank deposits – typically a stable and relatively inexpensive form 
of bank funding – which would be partially substituted. The extent of bank deposit substitution 
would depend on the relative attractiveness of the digital euro and could, depending on the 
magnitude, have adverse consequences for banks’ liquidity, profitability and overall resilience. This, 
in turn, could affect the provision of a wide range of intermediation and financial services by the 
banking sector.53 

In the absence of adequate holding limits, the materialisation of high deposit outflows could 
heighten liquidity risk for significant institutions. An analysis based on a constrained balance 
sheet optimisation model54  suggests that liquidity risk for significant institutions might only become 
significant if 20% of the stock of overnight deposits were withdrawn from the banking system.55  For 
key liquidity metrics such as the net stable funding ratio (NSFR) and the liquidity coverage ratio 

53    The theoretical literature on the impact of introducing a CBDC leads to different conclusions, depending 

on the theoretical framework employed. For a review of the literature, see Ahnert, T. et al., “The 
economics of central bank digital currency”, Working Paper Series, No 2713, ECB, 2022. 

54    A bank’s reaction to CBDC demand (deposit outflows) is simulated using a constrained balance sheet 

optimisation model in which a bank is expected to maximise profits, subject to some constraints. A bank 
sequentially (i) draws down its own reserves (until reserves-depleted or NSFR/LCR-constrained), (ii) 
obtains market funding (until liquidity or collateral-constrained), and (iii) obtains additional reserves 
from the central bank. For an overview of the model, see Meller, B. and Soons, O., “Know your 
(holding) limits: CBDC, financial stability and central bank reliance”, Occasional Paper Series, No 326, 
ECB, 2023. 

55    The results presented hinge on the level of reserves available in the system. All things being equal, a 
lower level of reserves would imply that banks would have to rely more on the interbank market or 
central bank funding to accommodate the same level of deposit outflows. 

Financial Stability Review, November 2023 – Euro area banking sector 

64 

Leading to a partial substitution of bank deposits Ensuringa monetaryanchor rolefor the euro in the digital eraEnhancing the availability and usability of central bank moneySupportingcompetitionand spurringinnovationProtecting monetary sovereigntyProspective role in systemic bank runs in periods of stressProviding an alternative to new forms of private digital money0204060801001201401601800510152030NSFRLCRRegulatory minimum 
 
 
 
 
 
(LCR), the current level of voluntary buffers that significant institutions hold above the regulatory 
minimum would progressively decrease as deposit outflows became larger (Chart B, panel b). 

However, the envisaged design of a digital euro would address financial stability concerns 
by applying adequate holding limits.56  The cap on individual holdings would set an upper bound 
for the amount of digital euro in circulation and prevent the materialisation of high deposit 
outflows.57  Recent studies show that setting a digital euro holding limit of €3,000 per person, as 
suggested by Bindseil and Panetta58, would be effective in containing the impact on banks’ liquidity 
risks and funding structures. With such a limit in place, outflows of household overnight deposits 
from the euro area banking sector could only occur (up to a maximum of 15%) in the following 
highly unlikely circumstances: (i) if all euro area citizens adopted the digital euro simultaneously, 
and (ii) they all shifted bank deposits to the digital euro at the upper bound of the holding limit 
instantaneously and then held these on a continuous basis. However, the actual level of the 
individual holding limit would be calibrated closer to the possible introduction of a digital euro to 
reflect the economic conditions prevailing at that time.   

Looking more broadly, recent experience has shown that digitalisation generally has the 
potential to speed up systemic bank runs in periods of stress in the absence of the 
necessary safeguards. An important lesson from the March 2023 events in the US banking sector 
was that bank runs can occur more swiftly in the digital era irrespective of any CBDC. That said, the 
introduction of a digital euro would not heighten the risk of idiosyncratic bank runs. A flight to safety 
towards a CBDC59  or another commercial bank deemed safer would depend on customers’ risk 
appetites and preferences. To prevent a CBDC increasing the latent risk of systemic bank runs 
during periods of stress, however, all currently applicable financial stability, central bank and bank 
risk management limits and tools should remain in place should a digital euro be introduced.   

3.4 

Improved solvency and rising capital distributions 

Solvency ratios have risen in 2023, supported by higher bank profitability and 
bank de-risking, with increased appetite for capital distributions. After declining 
in 2022, the aggregate Common Equity Tier 1 (CET1) ratio of euro area banks rose 
in the first half of 2023 to 15.3%, which is well above the aggregate maximum 
distributable amount (MDA) trigger of 11.1% (Chart 3.11, panel a). The increase of 
around 30 basis points was driven mainly by higher retained earnings on the back of 
improved bank profitability and declining average risk weights, reflecting a de-risking 
of banks’ portfolios. At the same time, rising total assets in the first quarter made a 

56    See “A stocktake on the digital euro: Summary report on the investigation phase and outlook on the 

next phase”, ECB, 2023. 

57    Business users would have a zero holding limit, meaning that they would not be able to accumulate 
holdings of digital euro, but they would be able to make specific types of payments. Similarly, 
governments and public authorities would be able to conduct transactions in digital euro without holding 
any digital euros in their wallets. 

58    See Bindseil, U. and Panetta, F., “Central bank digital currency remuneration in a world with low or 
negative nominal interest rates”, VoxEU, Centre for Economic Policy Research, 5 October 2020. 
59    This is not expected to occur thanks to the lines of defence currently in place, including effective 

banking regulation and supervision, deposit insurance and the central bank’s role as lender of last 
resort.   

Financial Stability Review, November 2023 – Euro area banking sector 

65 

 
 
 
 
negative contribution (Chart 3.11, panel b, left graph).60  The results of the European 
Banking Authority (EBA) stress test61, which were published at the end of July, show 
that euro area banks remain resilient overall, even under an adverse scenario which 
combines a severe EU and global recession, rising interest rates and higher credit 
spreads (Chart 3.11, panel a). The substantial recent improvement in bank 
profitability, the associated rise in banks’ management buffers and the high cost of 
equity have increased the appetite for capital distributions, which have been rising 
over the last two years (Chart 3.11, panel b, right graph). 

Chart 3.11 
Solvency of euro area banks has risen on the back of stronger profits, leading to an 
increasing appetite for capital distributions in the form of dividends and share 
buybacks 

a) Change in actual CET1 ratios and EBA 
2023 stress test results for euro area banks 

b) Decomposition of changes in euro area 
banks’ CET1 ratio and capital distributions 

(Q1 2018-26E, percentages) 

(left graph: H1 2023, percentages; right graph: 2017-23, 
percentages of total assets, percentages) 

Sources: Bloomberg Finance L.P., ECB (supervisory data) and ECB calculations. 
Notes: Panel a: based on a balanced sample of 81 euro area significant institutions. Panel b: the left graph is based on a balanced 
sample of 81 euro area significant institutions. The right graph is based on a balanced sample of 47 listed euro area banks. 
Information on dividends and share buybacks represent the payments as announced in each of the years. The year of announcement 
is usually also the year in which payments are made. Amounts represent the annual value of dividend payments and share buybacks 
scaled by the average total assets of all banks in the sample over the sample period. ROE for 2023 is a projection by market analysts. 

Global cyberattacks targeting financial institutions have continued to rise in 
2023. After reaching a new peak in 2022, the number of global cyberattacks 
detected across all economic sectors in the first five months of 2023 was broadly the 
same as last year. The number of attacks recorded in the financial sector globally 
this year is, however, about 30% higher than a year ago, highlighting just how 
serious the threat is. Accordingly, financial institutions need to ensure that they have 

60    There was also a positive contribution from sources of other comprehensive income, reflecting 

unrealised gains due to the introduction of IFRS 17 and the associated reclassification of banks’ 
financial assets under their insurance business, and also realised gains from banks’ portfolios of assets 
measured at fair value. 

61    See the July 2023 release of the EBA’s EU-wide stress test. 

Financial Stability Review, November 2023 – Euro area banking sector 

66 

6810121416182020182019202020212022202320242025CET1 ratio, 10-25th percentileCET1 ratio, 25-75th percentileCET1 ratio, medianCET1 ratioMDA triggerCET1 ratio, stress test baselineCET1 ratio, stress test adverse-0.3-0.2-0.10.00.10.20.30.40.50.60.7H1 2023Capital (retained earnings)Capital (other components)Total assetsRWA densityCET1 ratio change0123456789100.00.10.20.30.40.50.6201720202023DividendsBuybacksReturn on equity (right-hand scale) 
 
 
 
 
in place an adequate level of cyber resilience for their own protection as well as for 
that of the entire financial ecosystem. 

While market valuations of euro area banks have not recovered fully since the 
March turmoil, they have been outperforming the broader market in the year to 
date on the back of higher interest rates. Compared with their peers in other 
regions, notably Switzerland and the United States, euro area banks have seen their 
equity prices perform well this year (Chart 3.12, panel a, left graph). Euro area bank 
equities have gained 16% since the banking turmoil in March and are up 15% in the 
year to date. This is slightly above the broader market trend, driven partly by better 
than expected earnings results. The performance of bank stocks relative to the 
market continues to be driven strongly by interest rate expectations, as banks are 
perceived to be one of the main beneficiaries of policy rates remaining higher for 
longer (Chart 3.12, panel a, right graph). The rate sensitivity of their profitability is 
also reflected in bank stock prices performing differently across country lines, with 
outperformance evident in countries with larger increases in NIMs (Chart 3.12, 
panel b). 

Chart 3.12 
Bank stock prices have recovered since the March turmoil and the outperformance 
of the banking sector and across countries is being driven by rate sensitivity 

a) Bank stock price performance across 
global regions; bank stock price performance 
relative to the broader market 

b) Change in NIM and bank stock price 
performance at the country level relative to 
euro area aggregate 

(left graph: 2 Jan.-14 Nov. 2023, percentages; right graph:   
1 May 2022-14 Nov. 2023, percentages) 

(July 2022-Nov. 2023, percentage points, percentages) 

Sources: Bloomberg Finance L.P., ECB and ECB calculations. 
Notes: Panel a: the sample consists of 71 global listed banks. Share prices across regions are weighted by banks’ total assets. 

The difference between banks’ cost of equity (COE) and their ROE has not 
narrowed, with different factors at play, notably macroeconomic uncertainty 
and cost-inefficiencies. Indeed, the COE, an estimate of market participants’ 
compensation for investing into banks’ equity, rose alongside the ROE, as higher 
interest rates more than offset a narrowing in the equity risk premium. Since cross-
sectional differences in the COE can be partly attributed to bank fundamentals, 
lingering structural issues like cost-inefficiencies might explain why bank valuations 

Financial Stability Review, November 2023 – Euro area banking sector 

67 

-40-30-20-100102030405001/2304/2307/2310/23EAUSUKJapanSwitzerlandNordics-10-505101520250.91.41.92.42.93.43.905/2205/233M-rate, Dec. 24Bank/market perf. (right-hand scale)ATBECYDEESFIFRGRIEITMTNLPT-50-30-101030507090110130150-0.200.20.40.60.811.2Stock price performance since July 2022Change in NIM since July 2022 
 
 
 
have not picked up, as investors might have doubts about the sustainability of the 
recent rise in bank profitability (Box 5). 

Box 5 
Euro area bank fundamentals, valuations and cost of equity 

Prepared by Paul Bochmann, Maciej Grodzicki, Heinrich Kick, Benjamin Klaus and Cosimo Pancaro 

Euro area bank earnings have reached multi-year highs, while bank equity valuations have 
not substantially exceeded pre-pandemic levels. Between March 2022 and the end of the year, 
the share prices of euro area banks increased by 18% from the lows they reached after the start of 
Russia’s unjustified war against Ukraine, as earnings expectations recovered from the initial shock. 
The negative impact of higher risk-free rates on the net present value of future dividends paid by 
banks was broadly offset by reduced uncertainty about the prospects of the sector, as measured by 
the equity risk premium (Chart A, panel a). However, the equity risk premium widened abruptly in 
March 2023 during the banking tensions in the United States and Switzerland and continued to 
widen even when the tensions had abated. Taken together with increasing bank profitability, this 
pattern indicates increased uncertainty about the long-run sustainability of bank earnings. Bank 
equity risk premia have continued to weigh on valuations since the spring tensions. The aim of this 
box is to shed light on the cost of equity (COE) and market valuations in the banking sector and to 
reach a better understanding of the role of bank fundamentals in this context.62 

Banks’ exposure to corporate credit risk and the perception of their stocks as value stocks 
have contributed to the stagnant valuations of the banking sector in 2023. Factor models of 
time-varying COE make it easier to understand the drivers of change in banks’ equity risk premia. 
These models confirm that a large part of the overall increase in the COE can be attributed to the 
mechanical effects of higher risk-free rates. However, they also reveal concerns about banks’ 
exposure to credit risk, which have depressed bank valuations since the end of 2022 (Chart A, 
panel b). Bank valuations have also come under pressure due to their exposure to a factor 
capturing risks associated with value stocks. While banks are attractive because of the steady 
dividend income they do not offer any growth opportunities.63 

62    Banks’ market valuations are driven by changes in their return on equity and COE, among other things. 
If the price-to-book ratio – defined as a bank’s market capitalisation divided by the accounting value of 
its equity – is higher (lower) than 1, this means that its return on equity is higher (lower) than its COE. 
All else equal, a higher COE implies a lower valuation. 

63    This can be inferred from the increased positive contribution of the Fama-French HML factor, which 

represents the excess returns on value stocks compared with growth stocks. 

Financial Stability Review, November 2023 – Euro area banking sector 

68 

 
 
 
Chart A 
Bank valuations face headwinds from greater uncertainty, higher risk-free rates and credit risk 

a) Estimated contribution of fundamental factors to 
changes in euro area bank share prices 

b) Cumulative change in bank COE since end-2021, 
by risk factor 

(1 Jan. 2022-3 Nov. 2023, percentage points) 

(Q1 2022-Q3 2023, percentage points) 

Sources: LSEG, Kenneth French’s data library and ECB calculations. 
Notes: Panel a: based on a dividend discount model using COE, which includes a risk-free rate and an equity risk premium, as a discount factor. For details, 
see Fuller and Hsia*. A lower equity risk premium implies a positive contribution to share prices. Panel b: COE is not directly observable. The chart presents a 
decomposition of its estimates based on two orthogonalised factor models: one based on market factors and the other on Fama-French factors; see Altavilla 
et al.** The risk-free rate is the one-year overnight index swap rate. The market risk factor is the return on a market equity portfolio. Corporate credit and 
sovereign risks are captured using returns on indices covering BBB-rated corporate bonds and lower-rated euro area sovereign bonds. The HML factor 
represents the difference between returns on value stocks and growth stocks. The SMB factor represents the difference between returns on small cap equities 
and large cap equities. Factor models employ time-varying beta estimates but static risk premia. The contributions of individual factors represent quarterly 
averages of weekly data. HML stands for high minus low; SMB stands for small minus big. 
*) Fuller, R. and Hsia, C., “A simplified common stock valuation model”, Financial Analysts Journal, No 40, 1984, pp. 49-56. 
**) Altavilla, C., Bochmann, P., De Ryck, J., Dumitru, A., Grodzicki, M., Kick, H., Melo Fernandes, C., Mosthaf, J., O’Donnell, C. and Palligkinis, S., “Measuring 
the cost of equity of euro area banks”, Occasional Paper Series, No 254, ECB, 2021. 

Stagnant bank valuations cannot be fully explained by the fundamentals but may also be 
due to heightened uncertainty about shareholder access to returns earned by banks. There is 
empirical evidence that a lower COE is associated with lower leverage, better cost-efficiency and 
better asset quality.64  Based on a cross-section of listed euro area banks, these patterns continue 
to hold. Improving fundamentals are estimated to have reduced the COE by about 0.6 percentage 
points in 2022 (Chart B, panel a). A sensitivity analysis of the bank price-to-book ratio shows that 
other factors beyond profitability and capital, such as distribution policies and taxation of profits, can 
have a large impact on bank valuations. As banks have limited growth opportunities to earn returns 
commensurate with their COE, distributing a higher share of profits to investors leads to improved 
valuations. Conversely, the risk of the dividend income stream being taxed affects valuations more 
strongly relative to growth stocks, which reinvest cash flows internally and are expected to return 
them to investors in the more distant future (Chart B, panel b). 

64    See, for example, Altavilla, C., Bochmann, P., De Ryck, J., Dumitru, A., Grodzicki, M., Kick, H., Melo 

Fernandes, C., Mosthaf, J., O’Donnell, C. and Palligkinis, S., “Measuring the cost of equity of euro area 
banks”, Occasional Paper Series, No 254, ECB, 2021; the special feature entitled “Common equity 
capital, banks’ riskiness and required return on equity”, Financial Stability Review, ECB, December 
2011; and Bogdanova, B., Fender, I. and Takáts, E., “The ABCs of bank PBRs”, BIS Quarterly Review, 
Bank for International Settlements, March 2018. 

Financial Stability Review, November 2023 – Euro area banking sector 

69 

-50-40-30-20-100102030405001/2204/2207/2210/2201/2304/2307/2310/23Banks indexEarningsRisk-free rateEquity risk premiumResidual-2-1012345678Q1 2022Q2 2022Q3 2022Q4 2022Q1 2023Q2 2023Q3 2023Risk-free rateMarket riskCorporate credit risk Sovereign risk-2-1012345678Q1 2022Q2 2022Q3 2022Q4 2022Q1 2023Q2 2023Q3 2023Risk-free rateMarket risk HML factorSMB factor 
 
 
 
 
Chart B 
Fundamentals, distribution policies and taxation affect the attractiveness of bank stocks to investors 

a) Relationship between bank fundamentals and 
COE 

b) Sensitivity of bank valuations to changes in 
profits, taxation and distribution policy 

(left graph: change in COE attributed to bank-specific factors since 2022, 
contributions in percentage points; middle and right graphs: Q2 2023, x-
axis: normalised financial ratios, multiples of standard deviation; y-axis: 
COE, percentages) 

(price-to-book ratio: percentages; effects: percentage points) 

Sources: ECB (supervisory data) and ECB calculations. 
Notes: Panel a: left graph based on Altavilla et al.* using a regression approach to explain changes in COE with bank-specific fundamental factors. This 
approach is complementary to the factor model analysis presented in Chart A, panel b. CIR stands for cost/income ratio. Interbank deposit ratio is calculated 
as the ratio of interbank deposits to total assets and is used as a proxy for reliance on unstable funding. Middle and right graphs: bank fundamental variables 
are standardised to facilitate comparability. Bank-level COE based on Altavilla et al.* Panel b: sensitivities are estimated using a dividend discount model for a 
representative euro area bank assumed to earn a return on equity of 15% (before tax), pay a 25% tax rate and distribute 50% of net profits after tax and 
Additional Tier 1 coupons to investors. Assumed changes to these parameters correspond to about one-fifth of the observed input parameters. 
*) Altavilla, C. et al., “Measuring the cost of equity of euro area banks”, Occasional Paper Series, No 254, ECB, 2021. 

Weak bank stock valuations and a high COE increase the cost of lending to the real 
economy and make it harder for banks to raise capital. Uncertainty about the outlook for bank 
profits and asset quality, coupled with concerns about the sustainability of dividend payouts 
following announcements of higher bank taxes, is contributing to the stagnant valuations and 
persistently high equity risk premia observed in the euro area banking sector. In the long run, this 
may adversely affect financial stability as banks which are valued by investors at a discount will 
likely find it more challenging to raise new equity when needed. As capital required to support 
lending is remunerated by lending rates, weak valuations translate directly into stricter terms and 
conditions for finance to the real economy. 

Financial Stability Review, November 2023 – Euro area banking sector 

70 

-0.7-0.6-0.5-0.4-0.3-0.2-0.10.00.1CET1 ratioNPL ratioInterbank deposit ratioCIRSize10111213141516171819-2-10123ROE10111213141516171819-2-10123Leverage ratio21.66.55.3-7.4020406080100120Current P/Bratio3 pp increasein pre-taxROE0.8 ppdecrease inrisk-free rates10 ppincrease inpayout ratio5 pp increasein tax rate onprofitsP/B ratioPositive effectsNegative effects 
 
 
 
 
4 

Non-bank financial sector 

4.1 

Non-banks have proved resilient recently but may face 
challenges ahead as structural vulnerabilities persist 

Investment activity in the non-bank financial intermediation (NBFI) sector has 
picked up again in 2023, supporting debt issuance by sovereigns and 
corporates. Despite the uncertain macroeconomic environment (Chapter 1) and 
challenging financial market conditions (Chapter 2), investment funds (IFs) and 
insurance corporations and pension funds (ICPFs) have proved resilient recently and 
remain very active in primary debt markets. The sector continued to rebalance its 

Financial Stability Review, November 2023 – Non-bank financial sector 

71 

Q1 2020Liquidity and leverage risks in funds persistRising credit riskin portfoliosInsurers could face profitability challengesExposures to declining real estate valuationsRising credit risk could add to liquidity and leverage concerns in non-banks• Rising credit risk in portfolios• Liquidity and leverage risks in funds persist• Exposures to declining real estate valuations• Insurers could face profitability challenges83%94%20182019202020212022Outflows (5% exp. shortfall)Median HQLA stockRatio of life insurers' claims to premiumsInvestment funds’liquidity and worst outflows (% of TNA)30-4Q12022Q22023Revaluations in real estate investment funds (€ bn)Negative outlook1.1%5.0%9.7%21.6%Q12022Q32023EDowngradedCredit risk in non-banks' bond portfoliosLowMediumHighLiquidityFunds' synthetic leverage352024Notional / margin964124518181717SovereignCorp. HYCorp. IGEquity 
 
 
investment portfolios towards comparatively safer assets in the first half of 2023. The 
total value of bond portfolios, which was significantly affected by revaluation losses 
in 2022, has increased once again. This has been driven by rising active 
(re)investment in mostly higher-rated debt securities (Chart 4.1, panel a). As of mid-
2023, cumulative purchases in the highest-rated bonds over one year have been 
close to the record levels seen during the post-pandemic recovery (Chart 4.1, panel 
b). The NBFI sector has also increased its investments in bank bonds, although 
demand for bank equities has remained muted since the banking sector turmoil in 
March of this year (Chart 4.1, panel c). Overall, this highlights the sector’s ongoing 
important role in financing banks (Chapter 3), non-financial corporations and 
sovereigns (Box 1). 

Chart 4.1 
The NBFI sector has continued to rebalance portfolios, including by further 
increasing its purchases of bank debt and higher-rated bonds in primary debt 
markets 

a) Drivers of changes in euro 
area NBFI sector bond 
portfolios, by credit rating 

b) Euro area NBFI sector 
purchases of newly issued 
bonds, by credit rating 

c) Euro area NBFI sector net 
purchases of debt and 
equities issued by euro area 
banks 

(Q1 2020-Q2 2023; left-hand scale: 
€ trillions; right-hand scale: percentages) 

(Q1 2019-Q2 2023, € billions) 

(Q1 2022-Q2 2023, € billions) 

Sources: ECB (SHS, CSDB), S&P Global Market Intelligence, Moody’s Analytics, Fitch Ratings, DBSR Morningstar and ECB 
calculations. 
Notes: All amounts at market value. Panel a: IG stands for investment grade. Panel b: purchases of long-term bonds issued in the 
same quarter, accumulated over the past four quarters to account for seasonality. 

Against a backdrop of macroeconomic uncertainty and tighter financial 
conditions, the NBFI sector remains vulnerable to rising credit risks. Over the 
past year, NBFI sector bond portfolios have seen an increase in rating downgrades, 
with amounts rising above pre-pandemic levels (Chart 4.2, panel a). Downgrades in 
this context have mostly been concentrated among higher-rated issuers. At the same 
time, the credit outlook has deteriorated for several issuers, given the continuing high 
level of macroeconomic uncertainty, persistent inflation and tighter financial 
conditions. As a result, and despite rebalancing towards comparatively safer assets, 
the NBFI sector is now exposed to higher levels of holdings that have been given a 

Financial Stability Review, November 2023 – Non-bank financial sector 

72 

-9-6-3036-0.9-0.6-0.30.00.30.6Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q22020202120222023Transactions (IG excluding BBB)Transactions (BBB)Transactions (high yield)RevaluationChange in market value (right-hand scale)0100200300400500600Q12019Q12020Q12021Q12022Q12023Investment grade (excluding BBB)BBBHigh yield-10-50510152025303540Q1Q2Q3Q4Q1Q220222023BillionsDebt securitiesListed shares 
 
 
 
 
negative credit outlook – these could be downgraded in the near future, implying 
possible revaluation losses (Chart 4.2, panel b). The increase in holdings at risk of 
rating downgrades has been concentrated primarily among sovereign issuers. This 
reflects both the forthcoming substantial refinancing needs of several governments 
(Chapter 1, Box 1) and the high share of sovereign bonds in non-banks’ portfolios. 
Rising credit risk may cause losses for riskier IFs and weigh on ICPF profitability, 
increasing the risk of redemptions and policy lapses65  respectively, while also 
reducing the financial intermediation capacity of the NBFI sector (Sections 4.2 and 
4.3). 

Chart 4.2 
A weaker macroeconomic outlook and tighter financial conditions have increased 
credit risk in NBFI sector portfolios 

a) Downgrades in euro area NBFI sector bond 
portfolios 

b) Holdings in NBFI sector bond portfolios 
with negative and positive rating outlooks 

(Q1 2020-Q3 2023E; left-hand scale: € trillions,   
right-hand scale: percentages) 

(Q1 2020-Q3 2023E; left-hand scale: € trillions, 
right-hand scale: percentages) 

Sources: ECB (SHS, CSDB), S&P Global Market Intelligence, Moody’s Analytics, Fitch Ratings, DBSR Morningstar and ECB 
calculations. 
Notes: All amounts are four quarter moving averages at market value. Values for Q3 2023 are estimated by applying observed rating 
and outlook action in Q3 on the latest available holdings data referring to Q2 2023. Panel a: higher-rated bonds are defined as those 
with a worst issuer rating of AA- or higher. Panel b: total value of bonds from issuers that have been given a positive or negative credit 
outlook by at least one rating agency, excluding holdings with no or contradictory outlooks. The share of a bond portfolio with net 
positive outlook is given by the sum of positive less negative outlook holdings divided by total bond portfolio holdings. 

A deterioration in the macroeconomic outlook or wider adverse shocks could 
trigger sudden liquidity needs in the NBFI sector. Given that liquidity buffers in 
the NBFI sector remain very low, sudden investment fund outflows, large margin 
calls or lapsing insurance policies could lead to forced asset sales, which would 
amplify downward pressures in financial markets. Pursuing policies aimed at 
strengthening the liquidity and liquidity preparedness of the NBFI sector from a 
macroprudential perspective therefore remains of great importance in safeguarding 
financial stability across the sector and the wider financial system (Chapter 5, Box 
6). 

65    A policy lapse occurs when a policyholder stops paying the policy premium, in which case the benefits 

and coverage provided under the policy are terminated. 

Financial Stability Review, November 2023 – Non-bank financial sector 

73 

02468100.00.20.40.60.81.0Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3E2020202120222023Higher-rated bondsLower-rated bondsShare of total bond portfolio (right-hand scale)-25-20-15-10-50510152.52.01.51.00.50.00.51.01.5Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3E2020202120222023Non-financial corporationsSovereignsFinancial corporationsShare of bondportfolio withnet positive outlook (right-hand scale)Positive outlookNegativeoutlook 
 
 
 
 
4.2 

Risks related to liquidity and leverage point to structural 
vulnerabilities in investment funds 

Euro area investment funds continue to shift their bond portfolios towards 
higher-rated debt, but the uncertain macroeconomic outlook could trigger 
renewed revaluation losses. Compared with 2022, investments in the first two 
quarters of 2023 were more strongly focused on purchases of investment-grade 
sovereign and corporate bonds, while sales of high-yield debt securities ceased 
(Chart 4.3, panel a). However, investment-grade sovereign bonds were particularly 
sensitive to revaluation losses during 2022 (Chart 4.3, panel b). While more limited 
in 2023 to date, losses could potentially be triggered by the uncertain 
macroeconomic outlook (Overview, Chart 5, panel b). 

Fund flows mirror the shift observed in funds’ debt securities portfolios. 
Inflows into euro area-domiciled sovereign and investment-grade corporate bond 
funds are increasing, as safe assets are performing well in the current environment. 
This aligns with the shift observed in the fund sector’s bond portfolios. At the same 
time, there have been significant net outflows from equity funds invested in the 
financial sector since the episode of banking stress in March of this year (Chart 4.4, 
panel b). 

Chart 4.3 
Investment funds continue to shift to safer bonds, mitigating financial stability 
concerns, but revaluations of their debt securities portfolios might still pose 
challenges 

a) Euro area investment funds’ debt 
securities transactions, by rating and issuer 
sector 

b) Revaluations of euro area investment 
funds’ debt securities portfolios, by rating 
and issuer sector 

(Q1 2021-Q2 2023, € billions) 

(Q1 2021-Q2 2023, percentages of total market value) 

Sources: ECB (CSDB, SHS), S&P Global Market Intelligence, Moody’s Analytics, Fitch Ratings, DBSR Morningstar and ECB 
calculations. 
Note: The analysis excludes unrated bond holdings. 

Decreasing net inflows into real estate investment funds (REIFs) might amplify 
negative effects on the real estate cycle. In recent quarters, REIFs have 
experienced decreasing net inflows – and even net outflows in some jurisdictions – 

Financial Stability Review, November 2023 – Non-bank financial sector 

74 

-40-20020406080Q1 2021Q2 2021Q3 2021Q4 2021Q1 2022Q2 2022Q3 2022Q4 2022Q1 2023Q2 2023Q1 2021Q2 2021Q3 2021Q4 2021Q1 2022Q2 2022Q3 2022Q4 2022Q1 2023Q2 2023Non-financial corporationsSovereignInvestment grade (excluding BBB)BBBHigh yield-12-10-8-6-4-2024Q1 2021Q2 2021Q3 2021Q4 2021Q1 2022Q2 2022Q3 2022Q4 2022Q1 2023Q2 2023Q1 2021Q2 2021Q3 2021Q4 2021Q1 2022Q2 2022Q3 2022Q4 2022Q1 2023Q2 2023Non-financial corporationsSovereignInvestment grade (excluding BBB)BBBHigh yield 
 
 
 
and revaluation losses (Chart 4.4, panel a) in a context of monetary policy 
tightening, a turning real estate cycle and higher bond yields, all of which have 
contributed to making these funds less attractive for investors. Given the importance 
of REIFs for the real estate market, instability in this segment is especially 
concerning as it could amplify risks to the real estate sector.66 

Financial stability concerns about stress in the Chinese real estate market 
spilling over to the euro area investment fund sector are currently limited. Net 
inflows into funds investing in Chinese equities began to slowly decrease at the start 
of the year, before turning into outflows as of the end of August 2023 (Chart 4.4, 
panel b). This dynamic reflects the real estate stress affecting the Chinese economy 
(Chapter 2). That said, in September 2023 China-focused investment funds 
accounted for less than 1% of the total net asset value of euro area-domiciled equity 
funds.67  The limited and decreasing relevance of such funds is mitigating financial 
stability concerns about direct spillovers from Chinese market stress to the euro area 
investment fund sector. At the same time, a slowdown in China might have 
repercussions for the investment fund sector through its macroeconomic effects on 
the euro area economy or via adverse sentiment effects in financial markets. 

Chart 4.4 
Fund flows reflect the current macroeconomic environment 

a) Inflows and revaluations in real estate 
funds in the euro area 

b) Cumulative flows into euro area-domiciled 
bond and equity funds, by type 

(Q1 2020-Q2 2023, € billions) 

(2 Jan.-14 Nov. 2023, percentages of net asset value) 

Sources: ECB (IVF), EPFR Global and ECB calculations. 
Notes: Panel a: implied revaluations are calculated as the difference between the quarter-on-quarter change in net asset value minus 
net inflows. Panel b: IG stands for investment grade; HY stands for high yield. 

Despite the ongoing de-risking process, the euro area investment fund sector 
remains vulnerable to liquidity risks. Cash buffers in equity and bond funds 
remain low in a context of tightening financial conditions, although they proved to be 
adequate for the level of aggregate net outflows that these funds experienced during 

66    See also the box entitled “Institutional investors and house price growth”, Financial Stability Review, 

ECB, May 2023, and the article entitled “The growing role of investment funds in euro area real estate 
markets: risks and policy considerations”, Macroprudential Bulletin, Issue 20, ECB, April 2023. 

67    Data from EPFR Global. 

Financial Stability Review, November 2023 – Non-bank financial sector 

75 

-20-15-10-505101520253035Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q22020202120222023Net inflowsImplied revaluationsQuarter-on-quarter change in net assets-20-15-10-505101501/2303/2305/2307/2309/2311/23Bond -SovereignBond -Corporate IGBond -Corporate HYEquity -FinancialsEquity -TechnologyEquity -China 
 
 
 
 
relatively volatile market conditions in 2022 (Chart 4.5, panel a). Aggregate statistics 
do not, however, sufficiently capture liquidity risk or how associated structural 
vulnerabilities have evolved. These dimensions can be better assessed by looking at 
fund-level data and their distribution. Focusing on open-ended bond funds, their 
liquidity resilience to severe redemptions appears to have deteriorated compared 
with before the pandemic (Box 6, Chart B, panel a). In an adverse scenario, 
inadequate liquidity buffers could lead investment funds to engage in procyclical 
selling behaviour, potentially amplifying market corrections. 

Structural vulnerabilities in euro area investment funds may also be caused by 
leverage. This could be financial leverage through unsecured and secured 
borrowing, such as via repurchase agreements (repos) and other securities financing 
transactions, or synthetic leverage through derivative exposures. Excessive leverage 
can amplify stress and propagate shocks from the investment fund sector to the 
wider financial system, potentially leading to systemic issues. The distribution of 
investment funds’ financial leverage from repo borrowing68  shows that this type of 
leverage is low on average, but pockets of highly leveraged funds could be a source 
of financial stability concerns (Chart 4.5, panel b). The distribution of synthetic 
leverage tells a different story, however. One way to measure the leverage 
embedded in derivatives portfolios is by calculating the ratio of the portfolio’s gross 
notional value (GNV) to the initial margin (IM) posted.69  The data collected from a 
sample of investment funds’ equity derivatives portfolios show that the synthetic 
leverage stemming from these positions can be significant (Chart 4.5, panel c).70 

The combination of leverage, low liquidity buffers and high credit risk is a 
significant financial stability concern which underscores the need to 
strengthen the resilience of investment funds from a macroprudential 
perspective. As (synthetic) leverage can amplify shocks, especially when combined 
with liquidity and credit risk, it is important to consider these three aspects together.71 
Some of the funds with low liquidity buffers and risky asset portfolios might also be 
exposed to derivatives portfolios with a high level of synthetic leverage embedded,72 
making them especially vulnerable (Chart 4.5, panel c). Together with the other 
vulnerabilities discussed in this section, these risks highlight the need to strengthen 
the resilience of the investment fund sector from a macroprudential perspective 
(Chapter 5). 

68    This leverage is measured as the ratio of total repo borrowing (median over the quarter) to the net 

asset value of the fund. 

69    See also the box entitled “Synthetic leverage and margining in non-bank financial institutions”, 

Financial Stability Review, ECB, May 2022, and Avalos, F. and Sushko, V., “Margin leverage and 
vulnerabilities in US Treasury futures”, BIS Quarterly Review, BIS, September 2023. 

70    The ratio “GNV/IM posted” is a measure of synthetic leverage at activity level and not entity level. This 
means that it cannot be directly compared with the measure used to calculate the financial leverage 
stemming from repo borrowing, as the former is an activity-based measure and the latter an entity-
based measure. 

71    See also the box entitled “Non-banks’ liquidity preparedness and leverage: insights and policy 

implications from recent stress events”, Financial Stability Review, ECB, May 2023. 

72    A high level of synthetic leverage embedded in a derivatives portfolio does not necessarily imply that 
the overall level of synthetic leverage in the fund is high. The latter depends on the characteristics of 
the fund’s balance sheet. 

Financial Stability Review, November 2023 – Non-bank financial sector 

76 

 
 
 
Chart 4.5 
The euro area investment fund sector is vulnerable to risks from leverage and low 
liquidity buffers 

a) Cash buffers and recent 
fund flows as a share of total 
net assets 

b) Distribution of investment 
funds’ financial leverage from 
repo borrowing 

c) Distribution of investment 
funds’ synthetic leverage in 
equity derivatives portfolios, 
by quintiles of HQLA and 
cash holdings, and credit risk 
level of their portfolios 

(Q1 2021-Q2 2023, percentages) 

(Q2 2023, repo borrowing/net asset value) 

(30 Jun. 2023, GNV/IM posted) 

Sources: ECB (IVF, EMIR, SFTDS), EMIR sector enrichment based on Lenoci and Letizia*, LSEG Lipper IM and ECB calculations. 
Notes: Panel b: the leverage ratio is calculated as the median of the total repo borrowing during the quarter divided by the net asset 
value of the fund. Box plot whiskers represent the 5th and 95th percentiles of the distribution. Panel c: HQLA stands for high-quality 
liquid assets. The analysis only includes portfolios of centrally cleared equity derivatives. As at 30 June 2023, these portfolios 
accounted for 8% of the total centrally cleared derivative portfolio. The GNV/IM posted ratio is a measure of synthetic leverage at the 
portfolio level and as such does not capture the total synthetic leverage of an individual fund. For confidentiality reasons, box plot 
whiskers represent the 10th and 90th percentiles of the distribution where each observation consists of the aggregation of three funds. 
Liquidity buffers are expressed as the share of cash and HQLA in the total net assets of a fund. Part of these buffers might already be 
pledged as collateral for initial margins. The quintiles are ordered from lowest liquidity buffers to highest (i.e. the first quintile contains 
the lowest 20% of the liquidity buffer distribution). The credit risk of a fund is defined as the average credit risk of the fund’s portfolio. 
The credit risk score goes from 0 (lowest) to 10 (highest). The low credit risk sample includes all those funds whose portfolios have an 
average credit score below 3. 
*) See Lenoci, F.D. and Letizia, E., “Classifying Counterparty Sector in EMIR Data”, in Consoli, S., Reforgiato Recupero, D. and 
Saisana, M. (eds.), Data Science for Economics and Finance, Springer, Cham, 2021. 

4.3 

Insurers remain resilient, but rising economic uncertainty 
could challenge profitability 

Euro area insurers remain resilient overall, with strong profitability and 
solvency positions. Insurers continued to perform well in the first quarter of 2023. 
The aggregate profitability of large insurance groups – as measured by return on 
equity – continued to increase (Chart 4.6, panel a). Solvency Capital Requirement 
(SCR) ratios also remained well above the regulatory minimum of 100%, despite a 
recent decline (Chart 4.6, panel b).73  Furthermore, a falling combined ratio (defined 
as claim-related losses plus expenses divided by net premiums earned) in the first 
quarter of 2023 points to improved underwriting profitability for large non-life 
insurers, following the negative impact of inflation in 2022 (Chart 4.6, panel c). 

73    Note that where insurers employ transitional measures, the reported SCR ratio does not account for 
potential unrealised losses in their asset portfolios. For further discussion, see the “Report on Long-
Term Guarantee Measures and Equity Risk 2020”, EIOPA, December 2020. 

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-3-2-1012345678Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2202120222023Equity fund flowsBond fund flowsEquity funds’ cash bufferBond funds’ cash buffer0.00.51.01.52.02.53.03.5AllBondsMixedOtherInterquartile rangeMedian0102030405060708090100Hedge0204060801001201401601st2nd3rd4th5th1st2nd3rd4th5thLow credit riskHigh credit riskInterquartile rangeMedian 
 
 
 
 
 
Looking ahead, slower economic growth could pose profitability challenges for non-
life (re)insurers, as this could result in falling demand for new policies or rising 
numbers of policy lapses. 

Chart 4.6 
Insurers’ profitability and solvency remain strong in aggregate 

a) Return on common equity  b) Solvency Capital 

c) Combined ratio (non-life) 

Requirement ratio 

(Q2 2021-Q1 2023, percentages) 

(Q2 2021-Q1 2023, percentages) 

(Q2 2021-Q1 2023, percentages) 

Sources: Bloomberg Finance L.P. and ECB calculations. 
Notes: Data are based on a sample of large euro area insurers offering life and non-life products. The combined ratio is a common 
measure of non-life insurance profitability. 

Life insurers may also face challenges from declining underwriting 
profitability. While aggregate profitability (i.e. profitability from both investment and 
underwriting activities) continues to increase for the insurance sector as a whole, life 
insurers faced declining underwriting profitability in 2022 (as measured by the ratio of 
claims incurred plus acquisition expenses to premiums written) (Chart 4.7, panel a). 
This was primarily driven by falling real household incomes, which reduced demand 
for new life insurance policies, while policy lapses also increased marginally (Chart 
4.7, panel b). Profitability may remain a concern going forward, as slower growth 
could further weigh on demand for new policies and increase lapse rates. In addition, 
early redemptions of traditional savings products by policyholders may also pose a 
challenge for some life insurers, as higher interest rates could provide an incentive to 
reinvest in new contracts or alternative assets offering higher returns.   

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78 

0246810121416Q2Q3Q4Q1Q2Q3Q4Q1202120222023MedianInterquantile range180190200210220230240250Q2Q3Q4Q1Q2Q3Q4Q1202120222023MedianInterquantile range7580859095100105Q2Q3Q4Q1Q2Q3Q4Q1202120222023MedianInterquantile range 
 
 
 
 
Chart 4.7 
Euro area life insurers face challenges from falling profitability 

a) Ratio of claims incurred and acquisition 
expenses to premiums written 

b) Lapse rates on life business of large euro 
area insurance groups 

(2018-22, percentages) 

(2018-22, percentages) 

Sources: ECB (ICO, LIG) and ECB calculations. 
Note: Panel a: the chart shows observations for Q4 of each year for all insurance groups. 

Higher interest rates may increase the resilience of insurers and pension 
funds in the medium term, but it is important for them to strengthen their 
liquidity preparedness to meet margin calls. The recent gradual increase in 
interest rates is beneficial for insurance corporations and pension funds (ICPFs), 
given their negative duration gaps.74  It has also contributed to greater demand for 
higher-quality bonds from ICPFs in recent quarters (Chart 4.8, panel a). This may 
help to lower credit risk for ICPFs, though some exposures to vulnerable corporates 
remain (Section 4.1). Similarly, higher yields can alleviate concerns regarding the 
absorption of future sovereign bond issuance (Box 1). At the same time, any sharp 
increase in sovereign bond yields or a spike in financial market volatility could 
expose those ICPFs which use interest rate derivatives to large margin calls. Recent 
stress events, such as the March 2020 market turmoil and the UK gilt market 
episode, demonstrate how liquidity pressures faced by ICPFs can propagate stress 
across the wider financial system. This underscores how important it is for ICPFs to 
strengthen their liquidity preparedness to meet margin calls (Chapter 5). 

In the near term, higher interest rates may result in revaluation losses on 
exposures to assets and sectors, such as real estate, which are sensitive to 
interest rates. During the period of ultra-low interest rates that prevailed until last 
year, ICPFs significantly increased their holdings of less liquid assets, especially real 
estate. ICPFs generally have indirect exposure to real estate, mainly in the form of 
shares in euro area real estate investment funds (REIFs) (Chart 4.8, panel b). A 
decrease in incentives to search for yield could lead to a rebalancing of portfolios 
away from commercial real estate (CRE). Moreover, CRE prices have fallen recently 
as financial conditions have tightened (Chapter 1) and they remain at risk of further 

74    The duration gap refers to the difference between the duration of assets and liabilities. When the 

duration of assets is larger (smaller) than that of liabilities, the insurer has a positive (negative) duration 
gap. Insurers typically have a negative duration gap, whereas banks have a positive duration gap. 

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70758085909510020182019202020212022All insurersNon-lifeReinsurersLife012345620182019202020212022MedianInterquartile range 
 
 
 
 
correction, which could result in losses for ICPFs. Price corrections could also 
increase redemption pressures for REIFs, which could potentially lead to forced 
sales (Section 4.2) and hence losses for their investors, including ICPFs. Equally, 
the potential for losses could incentivise ICPFs to rebalance their portfolios away 
from CRE, including by means of redemptions from REIFs. In turn, this could 
contribute to potential liquidity pressures for REIFs. The ongoing correction in CRE 
markets and financial system interconnectedness warrant continued monitoring.   

Chart 4.8 
Higher interest rates continue to see ICPFs shift to safer assets, but could result in 
losses on real estate exposures 

a) ICPFs’ debt securities transactions, by 
rating and issuer sector 

b) ICPFs’ real estate assets, by type and 
region of exposure 

(Q1 2021-Q2 2023, € billions) 

(Q2 2023, € billions) 

Sources: ECB (SHS, CSDB), S&P Global Market Intelligence, Moody’s Analytics, Fitch Ratings, DBSR Morningstar, EIOPA and ECB 
calculations. 
Notes: Panel a: the chart shows net purchases of securities broken down by rating and issuer sector. Panel b: the chart is based on 
aggregate asset exposure statistics published by EIOPA. Data on pension funds reflect occupational pension schemes only. 
“Unknown” refers to mortgage exposures where the region of lending is unavailable in EIOPA data. “Equity” refers to holdings of real 
estate-related corporations. “Physical real estate” includes exposures to residential and commercial properties (excluding those for 
own use). 

Over the longer term, insurers will continue to face several fundamental 
challenges, including climate change. Estimated global insured losses of USD 
124 billion made 2022 one of the costliest years ever in terms of natural 
catastrophes.75  In Europe, three series of events alone – droughts in France, Storms 
Dudley, Eunice and Franklin in February 2022, and Storms Petra and Qiara in June 
2022 – generated direct economic losses of USD 17 billion and insured losses of 
USD 10 billon.76  The rising frequency of major natural catastrophes due to climate 
change and the growing magnitude of associated losses have also pushed up 
insurance prices. This adds to profitability challenges faced by non-life insurers and 
might widen protection gaps (the proportion of economic losses not covered by 
insurance), which may adversely affect the macroeconomic situation and financial 

75    See Banerjee, C., Bevere, L., Corti, T., Finucane, J. and Lechner, R., “A perfect storm: Natural 

catastrophes and inflation in 2022”, Swiss Re Institute, March 2023. 

76    See “Gallagher Re Natural Catastrophe Report of 2022”, Gallagher Re, January 2023. 

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-60-50-40-30-20-1001020304050Q1 2021Q2 2021Q3 2021Q4 2021Q1 2022Q2 2022Q3 2022Q4 2022Q1 2023Q2 2023Q1 2021Q2 2021Q3 2021Q4 2021Q1 2022Q2 2022Q3 2022Q4 2022Q1 2023Q2 2023Non-financial corporationsSovereignInvestment grade (excluding BBB)BBBHigh yield050100150200250300350400REIFsharesMortgagesEquityPhysicalreal estateDebtsecuritiesEuro areaRest of worldUnited StatesRest of EuropeUnknown 
 
 
 
 
stability. This highlights the importance of taking policy action to reduce the climate 
insurance protection gap.77 

Box 6 
Assessing liquidity vulnerabilities in open-ended bond funds: a fund-level redemption 
coverage ratio approach 

Prepared by Pierce Daly, Elisa Telesca and Christian Weistroffer 

Recent changes in the macroeconomic and financial landscape have underscored the need 
to reassess how liquidity vulnerabilities have evolved for euro area open-ended bond funds. 
The higher interest rate environment may have implications for open-ended investment funds 
exposed to interest rate-sensitive assets and sectors, such as high-yield corporate debt. This, 
together with recent episodes of liquidity stress in the fund sector (such as that seen in March 
2020), highlights the need to re-examine the resilience of bond funds to liquidity shocks. Based on a 
newly constructed, granular dataset of funds’ portfolio holdings and flows,78  this box explores how 
funds’ resilience has evolved since the coronavirus (COVID-19) pandemic and resulting market 
turmoil. It considers the share of high-quality liquid assets (HQLA) in fund portfolio assets as well as 
funds’ redemption coverage ratio (RCR), calculated by dividing the value of available HQLA stock 
by net outflows experienced in a severe but plausible scenario lasting 30 days.79 

Overall reduced HQLA levels for bond funds would suggest that they have greater liquidity 
mismatch, which would increase vulnerabilities should the sector face severe outflows. 
Despite ongoing de-risking by the sector, the median share of HQLA holdings has generally fallen 
across the sample since the end of 2019, reflecting revaluations of underlying assets80  and 
suggesting that overall liquidity risk in the sector is higher than it was before the pandemic (Chart A, 
panel a). In particular and by definition, relatively less liquid Level 2 assets represent the bulk of the 
liquidity stock of investment-grade corporate bond funds. This exposes such funds to potentially 
higher liquidity risk, as the underlying market liquidity for these assets is prone to fall during 
stressed periods (Chart A, panel b). Moreover, although the aggregate net assets of bond funds in 
the sample have decreased,81  the overall sectoral market footprint has remained broadly stable 
over time and is relatively high in certain market segments.82  Any procyclical sell-off of less liquid 
assets during stressed periods could thus have an adverse impact on underlying markets. 

77   See “Policy options to reduce the climate insurance protection gap”, Discussion Paper, ECB-EIOPA, 

April 2023. 

78    The dataset combines fund-level holdings and flows from Lipper and security-level data from the ECB’s 
Centralised Securities Database (CSDB) for a sample (around 35%) of euro-area domiciled bond 
funds. 

79    The RCR builds on the Basel Liquidity Coverage Ratio requirements, according to which assets are 

considered HQLA if they can be easily and immediately converted into cash with little or no loss of 
value. See also Bouveret, A., “Liquidity Stress Tests for Investment Funds: A Practical Guide”, IMF 
Working Papers, No 2017/226, IMF, 2017; Metadjer, N. and Moloney K., “Liquidity analysis of Bond and 
Money Market Funds”, Economic Letter Series, Vol. 2017, No 10, Central Bank of Ireland, 2017; and 
“Stress simulation for investment funds”, ESMA Economic Report, ESMA, 2019.   

80    Euro area investment funds have been increasing purchases of investment-grade sovereign and 

corporate bonds, while the latter have also suffered negative revaluations (see Chapter 4 in this issue 
of the Financial Stability Review). 

81    The sample’s aggregate net assets decreased by 10%, in line with the 8% fall for euro area bond funds 
between Q4 2019 and Q2 2023 reported under ECB Investment Funds Balance Sheet Statistics (IVF). 
82    For example, the market share of euro area investment funds in euro area corporate bonds remained 
stable at 24% between Q4 2019 and Q2 2023, and that of euro area high yield corporate bonds at 
40%, reported under ECB Securities Issues Statistics (CSEC) and Securities Holdings Statistics (SHS). 

Financial Stability Review, November 2023 – Non-bank financial sector 

81 

 
 
 
Chart A 
Euro area bond funds’ liquid asset holdings have declined, increasing exposure to potentially higher 
liquidity risk 

a) Median HQLA stock, redemption shock and fund 
group size 

b) Weighted average HQLA holdings and stock, by 
liquidity level 

(x-axis: Jan. 2007-Dec. 2019 (transparent), Jan. 2007-June 2023 (solid), 
percentages of total net assets; bubble size: Dec. 2019, June 2023, € 
millions; y-axis: Dec. 2019, June 2023, percentages of total net assets) 

(Dec. 2019, June 2023; percentages of total net assets) 

Sources: LSEG Lipper IM, ECB (CSDB) and ECB calculations. 
Notes: Panel a: redemption shocks (plotted on x-axis) are calculated, for each fund type, as the 5% expected shortfall of the distribution of monthly net flows 
experienced by funds between January 2007 and December 2019 (transparent bubbles) and January 2007 and June 2023 (solid bubbles) – in line with the 
methodology applied by ESMA*. The expected shortfall averages net flows below the 5th percentile of the distribution. The size of the bubbles shows the total 
size of the fund groups in millions of euro for December 2019 (transparent bubbles) and June 2023 (solid bubbles). Panel b: HQLA holdings and stock are 
weighted by funds’ total net assets. Arrows connect the weighted average HQLA stock per sub-group in Q1 2019 and Q2 2023. Funds’ holdings are classified 
at the security-level according to the Basel Liquidity Coverage Ratio requirements for HQLA. HQLA Level 1 assets include cash, cash equivalents and 
qualifying government bonds; Level 2A and 2B include less liquid assets such as qualifying covered bonds, corporate bonds, asset-backed securities and 
stocks. The HQLA stock is then calculated by applying no haircut to cash and Level 1 assets, 15% to Level 2A assets and 40% to Level 2B assets. Both 
panels: funds are categorised into six sub-groups based on their portfolio holdings, i.e. when 60% or more of their total net assets are invested in the 
corresponding asset category. “AE sovereign” includes government bonds issued by advanced economies in accordance with the IMF country classification; 
for “Mixed corp.”, HY and IG corporate bonds collectively meet the 60% threshold; “Mixed focus” includes the remainder of funds not reaching the 60% 
threshold. AE stands for advanced economies; IG stands for investment grade; HY stands for high yield; EME stands for emerging market economies. 
*) See ESMA, “Stress simulation for investment funds”, ESMA Economic Report, 2019. 

The redemption coverage of bond funds in a severe outflow scenario has generally 
deteriorated since 2019. The RCR results suggest that funds in the sample are generally less 
resilient to redemption shocks now than they were four years ago. In particular, a large share of 
corporate and emerging-market bond funds would not have sufficient liquid assets to cover 
potentially large redemptions over a one-month period83  (Chart B, panel a). This is because such 
funds invest in less liquid markets and have historically suffered higher outflows than the other sub-
groups. While the share of entities with an RCR of below one has generally increased, the number 
of funds with a liquidity shortfall84  – defined as net outflows minus liquid assets – has decreased 
overall. However, shortfall levels remain quite high (i.e. more than 10% of total net assets) for a 
considerable share of funds in each group (Chart B, panel b). This is with the sole exception of 
investment-grade corporate bond funds, for which an increase in funds with a high liquidity shortfall 
suggests an even larger uptick in vulnerabilities than for the other groups. 

83    Assuming funds first sold liquid asset to meet outflows. 
84    For funds with a RCR of less than 1, a larger liquidity shortfall implies that the fund would need to sell 

more illiquid assets to cover severe redemptions. 

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82 

-20-10010203040506070809010011012012131415161718192021222324MedianHQLA stockRedemption shockAE sovereignIG corp.HY corp.Mixed corp.Mixed focusEME2023201905101520253035402019202320192023201920232019202320192023HY corp.EMEIG corp.Mixedcorp.MixedfocusHQLA stockCashLevel 1Level 2ALevel 2B02040608010020192023AEsovereign 
 
 
 
 
Chart B 
Corporate and emerging-market bond funds show signs of material liquidity mismatch amid a 
sector-wide deterioration in resilience to severe redemptions 

a) Distribution of fund-level RCR, by fund type 

(Dec. 2019, June 2023; ratios) 

b) Share of funds with RCR < 1 and a high liquidity 
shortfall, by fund type 

(Dec. 2019, June 2023; left-hand-scale: percentages of funds in group, 
right-hand scale: number of funds in group) 

Sources: LSEG Lipper IM, ECB (CSDB) and ECB calculations. 
Notes: Panel a: the RCR is the ratio between the fund-level HQLA stock and the calculated group-level redemption shock, both expressed as a percentage of 
total net assets. Two shocks are applied for 2019 and 2023 respectively, the calibration of which is described in the notes to Chart A, panel a. The box plots 
display the distribution per fund group of the resulting fund-level RCRs in December 2019 and June 2023. Panel b: liquidity shortfall is defined as the 
redemption shock (net outflows) minus HQLA stock. The bars display the share of funds, in each fund category, with an RCR < 1 and a liquidity shortfall > 
10% of total net assets. 

Heightened liquidity vulnerabilities indicate that large-scale redemptions could lead to 
stress within the bond fund sector, with negative repercussions for the underlying markets. 
The RCR results are relevant in the current market environment where negative surprises 
concerning the credit and growth outlook could trigger large redemptions. This, in turn, increases 
the potential for forced asset sales, increasing the likelihood that stressed funds could amplify 
negative movements in underlying market prices and liquidity. Consequently, the results also 
highlight the need to better align asset liquidity with fund redemption terms, in line with the Financial 
Stability Board recommendations that seek to address structural liquidity mismatch in open-ended 
investment funds.85 

85    See “Addressing Structural Vulnerabilities from Liquidity Mismatch in Open-Ended Funds – Revisions 

to the FSB’s 2017 Policy Recommendations: Consultation report”, FSB, 2023. 

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012345201920232019202320192023201920232019202320192023HY corp.EMEIG corp.Mixedcorp.MixedfocusAEsovereignRCR thresholdInterquartile range (2019)Interquartile range (2023)Median20030040050060070080090010000102030405060708090100201920232019202320192023201920232019202320192023HY corp.EMEIG corp.Mixedcorp.MixedfocusAEsovereignShare of funds with RCR < 1Ofwhichwith liquidity shortfall > 10%Total number of funds (right-hand scale) 
 
 
 
 
 
5 

Macroprudential policy issues 

5.1 

Continue to preserve banking sector resilience to 
navigate the downturn 

In recent months, the euro area macroprudential authorities have continued to 
strengthen bank resilience by further increasing macroprudential capital 
buffers. Macroprudential actions have been facilitated by banks’ strong profitability 
and comfortable capital headroom, which have prevented any procyclical effects 
(Chart 5.1, panel a) in a context of lower credit demand and heightened aversion to 
risk on the part of banks.86  Specifically, macroprudential authorities have 
increasingly activated countercyclical capital buffers (CCyB), either to address 
vulnerabilities linked to the build-up of credit risk or to increase macroprudential 
space in the form of releasable capital buffers. Since the publication of the May 2023 
Financial Stability Review, five jurisdictions have either introduced or further 
tightened the CCyB, bringing the total number of countries with a positive CCyB rate 
in place to 13 (Chart 5.1, panel b). Thanks to the more active use of this instrument, 
the weighted average CCyB rate in the banking union rose from 0.23% at the onset 
of the pandemic to 0.58% in the second quarter of 2023.87  Since the pandemic, 
several countries have also introduced sectoral capital buffers to address 

86    As reported in the October 2023 euro area bank lending survey; see the ECB press release of 24 

October 2023. 

87    For further discussion, see the article entitled “A positive neutral rate for the countercyclical capital 
buffer – state of play in the banking union”, Macroprudential Bulletin, Issue 21, ECB, April 2023. 

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84 

Structural vulnerabilities persist in the non-bank financial sectorThe financial cyclecontinues to declineTighter financial conditions test private sector resilience•Preserve resilience by maintaining existing capital buffers•Explore opportunities for targeted measures, while avoiding procyclicality•Continue to ensure sound lending standards and the sustainability of household debt Continue to preserve banking sector resilience to navigate the downturn•Ensure the effectiveness of the regulatory framework for banks•Strengthen the policy framework for non-banks from a macroprudential perspective, while ensuring a globally consistent approachEnhance the regulatory framework to strengthen long-term resilience 
 
 
 
vulnerabilities in specific sectors such as the residential real estate and corporate 
sectors.88 

Chart 5.1 
Macroprudential actions have further fostered resilience and increased 
macroprudential space, while avoiding procyclical effects on lending 

a) Estimated lending impact of a 1 percentage 
point increase in capital requirements, 
depending on ROA and voluntary capital 
buffers 

b) CCyB rates in participating banking union 
countries and latest policy action 

(percentages) 

(percentages) 

Sources: Notifications from national authorities, Eurostat, ECB and ECB calculations. 
Notes: Panel a: interquartile range and 90-10th percentile range of the simulated impact on lending of a 1 percentage point increase in 
capital requirements based on the model in Lang and Menno*. The following category definitions apply: high ROA > 0.5; medium ROA 
[0.25, 0.5]; low ROA < 0.1; high voluntary capital buffer: greater than median; low voluntary capital buffer: lower than median. ROA 
stands for return on assets. ROA stands for return on assets. Panel b: announced rates for the CCyB as notified to the ECB by 
national authorities. The announced rate is already effective in Bulgaria, Germany, Lithuania, Luxembourg and Slovakia, while in other 
countries it will become effective by the end of 2023 (Estonia and Slovenia) or 2024 (Belgium, Ireland, France, Croatia, Cyprus and the 
Netherlands), one year after the announcement date.* 
*) Lang, J.H. and Menno, D., “The state-dependent impact of changes in bank capital requirements”, Working Paper Series, No 2828, 
ECB, July 2023. 

Macroprudential authorities should preserve macroprudential buffers to 
ensure that they remain available should conditions deteriorate in the banking 
sector. The turning of the financial cycle increases the risk that existing 
vulnerabilities – such as high private sector indebtedness and residential real estate 
price overvaluation – could lead to a disorderly unravelling. Furthermore, the full 
impact of tighter financial conditions and weak economic growth on the private sector 
has yet to be felt. So far there has been no sign of widespread losses, bank 
profitability is at a historical high, and dividend payouts have increased (Chapter 3). 
Existing capital buffers should therefore be maintained to preserve available 
macroprudential space and should only be used if widespread losses (or the 
expectation of such losses) were to materialise. The availability of releasable capital 
buffers helps to preserve trust in the banking system during the current challenging 
period and mitigates the risk that banks might unduly constrain the credit supply if 
distress were to occur. Furthermore, current levels of banking sector profitability may 
provide an opportunity for some countries to implement additional targeted increases 

88    Seven countries have introduced sectoral capital buffer requirements to address risks in the residential 
real estate sector (Belgium, Germany, Lithuania, Slovenia, Malta and Portugal) and the corporate 
sector (France).   

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-12-10-8-6-4-202High ROALow ROAHigh ROALow ROAHigh bufferLow bufferQ1-Q3 range90-10th percentile range0.00.51.01.52.02.5EEIECYLTNLBEBGDEFRHRLUSISKAnnounced rate as of May 2023 FSRLatest announced rateCountries with positive neutral CCyB rate 
 
 
 
 
of macroprudential buffers, which would strengthen macroprudential space. Finally, 
borrower-based measures should remain in place and continue to act as structural 
backstops to ensure that lending standards do not deteriorate and that borrowers’ 
debt remains sustainable. While meeting that objective, the flexibility embedded in 
the design of borrower-based measures in many countries could help to avoid 
excessive mortgage supply constraints and preserve credit accessibility for specific 
segments of borrowers. 

Recent initiatives imposing extraordinary taxes on credit institutions in some 
countries may have negative implications for financial stability. In the current 
macro-financial environment, it is extremely important to ensure that credit 
institutions maintain – or where necessary build on – a sound capital base so that 
they can continue to fulfil their role as credit intermediaries in the economy. In recent 
opinions on the subject89, the ECB has highlighted the potential for bank levies to 
make it harder for banks to build up additional macroprudential capital buffers, which 
would have negative repercussions on bank resilience and the lending supply should 
broader distress materialise. Finally, the heterogeneous nature of such extraordinary 
taxes and the possibility of double taxation for credit institutions operating through 
branches in different jurisdictions may lead to fragmentation in the European 
financial system. 

Ensure the effectiveness of the regulatory framework for banks 

The Basel Committee on Banking Supervision (BCBS) conducted an important 
stocktake of lessons learnt from the tensions in the US and Swiss banking 
sectors earlier this year, reaffirming that implementing Basel III remains a 
priority. A first key finding relates to the crucial role of sound risk management 
practices and internal governance by banks as a first line of defence. In addition, the 
BCBS highlighted the importance of strengthening supervisory effectiveness. 
Moreover, the BCBS has initiated targeted analyses to assess whether specific 
features of the Basel framework, such as liquidity risk and interest rate risk in the 
banking book, performed as intended during the March turmoil and will assess the 
need to explore policy options over the medium term. Notwithstanding the fact that 
the EU banking sector proved resilient during the turmoil, these lessons learnt and 
further analyses will offer important insights into potential improvements. 

The banking union has made considerable progress in reducing the 
complexities associated with the failure of systemically important banks active 
in multiple countries in the banking union. This progress was recognised at the 
global level in the methodology used to set capital buffers for global systemically 
important banks (G-SIBs). However, the framework used by the ECB to assess 
buffers set by national authorities for other systemically important institutions (O-SIIs) 
continues to treat all cross-jurisdictional activities within the banking union as being 

89    See the Opinion of the European Central Bank of 2 November 2022 on the imposition of temporary 

levies on certain credit institutions (CON/2022/36), the Opinion of the European Central Bank of 4 April 
2023 on the imposition of a temporary solidarity contribution (CON/2023/9) and the Opinion of the 
European Central Bank of 12 September 2023 on the imposition of an extraordinary tax on credit 
institutions (CON/2023/26). 

Financial Stability Review, November 2023 – Macroprudential policy issues 

86 

 
 
 
equally concerning, from a financial stability perspective, as exposures outside the 
banking union. The existence of single supervision and resolution mechanisms 
substantially reduces the frictions which affect the supervision and resolution of 
internationally active banks, although differences remain as some elements of the 
banking union are yet to be completed. The ECB is therefore carrying out the 
technical work required to explore different options for recognising the banking union 
in its O-SII framework. 

5.2 

Enhancing the policy framework for non-bank financial 
intermediation 

Parts of the non-bank financial intermediation (NBFI) sector exhibit significant 
vulnerabilities, highlighting the need to strengthen the resilience of the sector 
from a macroprudential perspective. Vulnerabilities may arise from liquidity 
mismatch or leverage across a range of non-bank financial institutions.90  These 
vulnerabilities have crystallised during several periods of stress in recent years, 
notably the March 2020 market turmoil, the failure of Archegos Capital Management 
in 2021 and the UK government bond (gilt) market stress in 2022. In some cases, 
extraordinary policy responses from central banks were needed to stabilise markets 
and limit contagion to the wider financial system.91  Given the increasingly important 
role played by the NBFI sector in financing the real economy and its interconnections 
with the banking system,92  it is important to tackle the sector’s vulnerabilities to 
enhance financial stability and support monetary policy in fulfilling its objectives.   

A comprehensive set of policy measures should be developed to address 
vulnerabilities in the NBFI sector holistically. Such an approach would consider 
interdependencies across different parts of the financial sector as well as interactions 
between policies, such as those between approaches to tackle liquidity risk and 
leverage in the NBFI sector. In this context, it is important to recognise the 
heterogeneous nature of the non-bank financial sector. Different business models 
and balance sheet structures require that the policy measures will be tailored to 
specific entity types and their business models. It is also essential to ensure that the 
economic benefits of any new policy measures exceed their economic costs (e.g. 
through calibration). 

The policy approach should take existing frameworks into account and be 
rooted in strong international coordination. A macroprudential approach to the 
NBFI sector should ideally include repurposing existing tools (i.e. by embedding 

90    This section focuses on investment funds, money market funds, insurers and pension funds. 
91    See the ECB blog posts by Luis de Guindos and Isabel Schnabel entitled “The ECB’s commercial 
paper purchases: A targeted response to the economic disturbances caused by COVID-19”, 3 April 
2020, and “Improving funding conditions for the real economy during the COVID-19 crisis: the ECB’s 
collateral easing measures”, 22 April 2020. For the Bank of England’s response to the UK gilt market 
stress in 2022, see “Bank of England announces gilt market operation”, news release, Bank of 
England, 28 September 2022. 

92    See the box entitled “Measuring market-based and non-bank financing of non-financial corporations in 

the euro area”, Financial Integration and Structure in the Euro Area, ECB, April 2022, and the special 
feature entitled “Key linkages between banks and the non-bank financial sector”, Financial Stability 
Review, ECB, May 2023. 

Financial Stability Review, November 2023 – Macroprudential policy issues 

87 

 
 
 
macroprudential perspectives) and consider developing additional macroprudential 
policies as well as assessing the role of the authorities in implementing them.93  In 
addition, the availability and use of granular data and metrics to assess 
vulnerabilities should be enhanced, including by better information sharing across 
jurisdictions. Given the pronounced cross-border dimension of NBFI activities, 
international policy coordination via the Financial Stability Board (FSB) will be an 
important way to promote a level playing field and minimise the risk of cross-border 
arbitrage. 

The structural vulnerabilities related to liquidity and leverage and their 
interaction mean it is vital to enhance the resilience of the NBFI sector from 
several angles. The remainder of this section focuses on policies aimed at (i) 
enhancing liquidity preparedness to meet large margin and collateral calls in 
derivatives and repo markets, (ii) containing leverage-related risks in the NBFI 
sector, and (iii) tackling liquidity mismatch in open-ended funds. Money market fund 
reforms are discussed briefly at the end of the section. 

Inadequate liquidity preparedness to meet margin and collateral calls can 
precipitate adverse feedback dynamics and amplify market-wide stress. Market 
participants may be forced to sell assets in periods of market stress, which can 
depress asset prices further and, in turn, accelerate margin calls, potentially 
transforming individual liquidity stress into a system-wide issue. This was the case in 
September 2022, when a sudden increase in gilt yields led to UK pension funds 
facing large margin calls on their interest rate derivative positions, prompting them to 
sell long-dated government bonds in thin underlying markets.94  Similarly, the large 
margin calls faced by EU insurance corporations and pension funds in March 2020 
triggered significant outflows from money market funds, which amplified the stress 
across the wider financial system.95 

It is therefore important to enhance the preparedness of NBFI sector entities to 
cope with liquidity needs stemming from large margin and collateral calls. 
Strengthening the governance and liquidity risk management of a broad range of 
non-bank entities, including investment funds, insurance corporations and pension 
funds, is the most direct way to enhance liquidity preparedness. The table below 
summarises promising policy options. These include enhancing contingency 
planning and governance, using liquidity stress testing and ensuring that there are 
appropriate levels of liquidity buffers and that liquidity sources are diversified. 

Policies should consider the trade-off between enhancing resilience to 
liquidity stress and wider economic costs and be calibrated in a way that 
ensures benefits outweigh costs. In addition, liquidity preparedness should be 
proportional to liquidity risk and should reflect the size of potential margin calls and 

93    The current FSB policy agenda focuses largely on repurposing existing policy tools. At a later stage, 
the FSB will assess whether there is a need to develop additional tools for use by the authorities. 
94    See the box entitled “Non-banks’ liquidity preparedness and leverage: insights and policy implications 

from recent stress events”, Financial Stability Review, ECB, May 2023. 

95    See the box entitled “Lessons learned from initial margin calls during the March 2020 market turmoil”, 
Financial Stability Review, ECB, November 2021, and Ghio, M., Rousová, L., Salakhova, D. and 
Villegas Bauer, G., “Derivative margin calls: a new driver of MMF flows”, Working Paper Series, No 
2800, ECB, March 2023. 

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the interplay with leverage. In this respect, liquidity stress testing and contingency 
planning may be useful when calibrating the appropriate level of liquidity buffers and 
the diversification of liquidity sources. 

Policy options for enhancing non-banks’ preparedness to meet margin and collateral calls 

Policy option 

Description 

Justification 

Contingency 
planning and 
governance 

Liquidity stress 
testing 

NBFI sector entities should be required to 
have effective contingency planning and 
governance practices in place to manage 
liquidity risks stemming from margin or 
collateral calls. Specifically, they should have 
clear action plans for different adverse 
scenarios and an effective governance 
structure for managing such calls. To the 
extent possible, the plans should reflect a 
system-wide perspective, for example, by 
taking into account the resilience of common 
sources of liquidity during periods of market-
wide stress. 

NBFI sector entities should be subject to 
appropriate stress tests to assess liquidity risk 
from margin and collateral calls under adverse 
scenarios. Guidelines, best practices, and 
recommendations should be developed for 
such stress tests. 

The authorities should have a clear mandate 
to follow up on the stress test results and 
demand action from supervised entities. 

Progress in this area would allow NBFI sector entities to better 
assess and manage their liquidity risks from margin and 
collateral calls. This could include enhancing collateral 
management practices and access to credit lines. It would also 
enable authorities to check whether the contingency plans are 
appropriate and to calibrate concrete liquidity measures 
accordingly. 

For larger institutions, the approach should be relatively less 
costly to implement. However, developing and maintaining the 
contingency plans would be relatively more expensive for 
smaller entities, highlighting the importance of proportionality. 

By gauging the resulting entity-level and system-wide liquidity 
needs, authorities and entities would be better placed to 
assess the ability to meet margin and collateral calls in periods 
of stress. Running stress tests should also enhance the 
available data at entity level, operate as a disciplining device 
and help strengthen entities’ risk management functions and 
contingency planning. In addition, the results could be used in 
the calibration of other policy measures such as the 
appropriate level of liquidity buffers and the diversification of 
liquidity sources. 

Stress testing can be resource-intensive, so it is important to 
consider proportionality when establishing any stress testing 
approach. 

Higher levels of 
liquidity 

NBFI sector entities should hold sufficient 
levels of high-quality liquid assets or cash 
buffers. Adequate levels may be higher than is 
currently the case. 

Ensuring that NBFI sector entities hold a sufficient level of 
liquid assets would directly enhance their ability to meet large 
margin and collateral calls, thereby enhancing system-wide 
resilience. 

While there are also costs associated with holding high-quality 
liquid assets and cash (e.g. costs arising from foregone 
revenues as well as the potential for greater market-wide 
scarcity of high-quality collateral), these should be weighed 
against the benefits of the increased resilience of individual 
NBFI sector entities and the wider financial system. The 
calibration of any policy measures in this area should ensure 
that benefits outweigh costs. 

Diversification of 
liquidity sources 

NBFI sector entities should diversify their 
liquidity sources, both across and within asset 
classes, and should avoid concentration in 
any particular type of collateral. 

On the funding side, entities should avoid 
excessive counterparty concentration for 
credit and repo lines. 

NBFI sector entities often rely on the same sources of liquidity 
and might not internalise the extent to which their individual 
actions could exacerbate systemic stress. Requiring liquidity 
source diversification should enhance the resilience of entities 
in response to widespread liquidity shocks, for example, by 
reducing dependence on the liquidity of particular assets under 
stress, and enhancing the availability of funding more broadly. 

While enhancing liquidity preparedness is mainly the responsibility of market 
participants, complementary measures related to margining practices and the 
resilience of liquidity provision should be considered. To that end, it would be 
useful to enhance transparency and reduce procyclicality in margin and collateral 
calls. For example, recent stress episodes have highlighted the need for greater 
transparency in the margin models of central counterparties and clearing members. 
This could entail gathering more information about how margin models work (e.g. 
information on discretionary add-ons/multipliers) and using better data and tools (e.g. 
margin simulators). In addition, enhancing collateral transformation services and 

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improving the resilience of repo and cash bond markets could be beneficial for the 
liquidity preparedness of NBFI sector entities. 

Both entity-based and activity-based measures should be used to address the 
risks related to NBFI sector leverage. Entity-based measures, such as rules that 
restrict leverage for certain NBFI sector entities, should be complemented by 
measures affecting certain activities (such as derivative or repo transactions) used to 
generate leverage. Given the complexities involved in the use of leverage in an 
interconnected financial system, the policy response should also take a holistic 
perspective which takes into account interactions with policies targeting liquidity risk. 
For instance, leverage limits could reduce the size of margin calls faced by non-bank 
financial institutions. At the same time, enhanced liquidity risk management would 
mitigate the need for forced asset sales, something which could have particularly 
strong amplifying effects for highly leveraged financial intermediaries. 

A globally consistent approach for measuring risks stemming from both 
financial and synthetic leverage would make it possible to monitor such risks 
more effectively.96  For this purpose, it is important to continue to develop globally 
consistent metrics and improve data quality and coverage as well as cross-
jurisdictional information sharing. This will make it easier to assess leverage-related 
risks across NBFI sector entities, activities and jurisdictions.97 

One key aspect of policy would be to consider leverage restrictions for 
different types of NBFI sector entity. This could include setting concrete leverage 
limits and/or using discretionary restrictions for types of entity with similar risk 
exposures.98  Calibrating such limits would require an assessment of appropriate 
levels of leverage for NBFI sector entities – this should take into account the specific 
business models of different entities, the economic benefits of such leverage and the 
level of leverage-induced externalities that the financial system could withstand. 
Stress testing could be informative in this case. It is also important to ensure that any 
regulatory requirements are not circumvented and that the authorities can address 
any arbitrage promptly should it occur. 

Enhancing prudential rules on haircuts and margins for securities financing 
(including repos) and derivative transactions should also be part of the 
approach to address NBFI sector leverage. Since not all NBFI sector entities 
would be subject to direct leverage constraints, a higher initial margin during periods 
of low market volatility would operate as a backstop limiting both the amount of 
leverage created through derivative exposures (synthetic leverage) and margin 

96    Financial leverage implies an on-balance-sheet exposure from the borrowing of funds. By contrast, 

synthetic leverage is usually obtained via derivative exposures and requires daily mark-to-market 
margining, which would expose entities to liquidity risk in the event of significant adverse price 
movements. 

97    This work should complement the previous done work by the International Organization of Securities 
Commissions (IOSCO) on investment funds. See “Recommendations for a Framework Assessing 
Leverage in Investment Funds”, Final Report, No 18/2019, IOSCO, December 2019. 

98    For instance, funds under the UCITS Directive are subject to different approaches to limit leverage, 
depending on the complexity of their investment strategy. Under Article 25 of the AIFM Directive, 
competent authorities can impose leverage limits on alternative investment funds to ensure the stability 
and integrity of the financial system. See also ESMA Guidelines on Article 25 of Directive 2011/61/EU, 
23 June 2021. 

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procyclicality. With regard to securities financing transactions, it is important to swiftly 
implement the FSB minimum haircut framework in European law. At the same time, 
the rules on haircuts and margins could have potentially adverse consequences for 
the cost of hedging for end users, highlighting the need to carefully balance benefits 
and costs.   

Finally, as part of a holistic approach it is important to consider how prime 
brokers and dealer banks facilitate NBFI leverage in accordance with their risk 
management practices and regulation. This is another important complementary 
aspect to consider with regard to mitigating the build-up of leverage in the NBFI 
sector globally, especially for entities that are not subject to regulatory leverage 
constraints. 

A key policy objective concerning liquidity mismatch in open-ended funds 
(OEFs) is to better align fund redemption terms with the liquidity of portfolio 
assets. The FSB has recently published proposals in support of this objective.99  In 
particular, the daily creation and redemption of fund shares would remain 
appropriate for funds that invest mainly in assets that are liquid under both normal 
and stressed market conditions (e.g. certain listed equities or government bonds). 
For funds invested in assets that are relatively less liquid during normal periods, but 
which could become illiquid under stress, such as corporate bond funds, daily 
redemptions may be appropriate if the asset manager can demonstrate to the 
authorities that higher standards of liquidity management are being met. However, 
the asset manager should consider longer notice periods or a lower redemption 
frequency to reduce liquidity mismatch vulnerability if the costs of selling assets 
cannot be passed on to redeeming investors by anti-dilution tools. Finally, it would 
not be appropriate for OEFs holding a significant share of assets (such as real estate 
assets) that are illiquid even under normal market conditions to offer daily liquidity to 
investors. National regulators and authorities supervising property funds in the EU 
have devised a range of policy measures to limit the liquidity mismatch in such 
funds.100 

Enhancing the availability and use of anti-dilution liquidity management tools 
should form part of the policy response to vulnerabilities in the OEF sector.101 
In particular, OEFs should be able to pass on to redeeming investors both the 
explicit and the implicit costs of selling assets under both normal and stressed 
market conditions to reduce first-mover advantages and disincentivise procyclical 
investor redemptions. This could be achieved by employing price-based anti-dilution 
tools such as swing pricing or anti-dilution levies, especially for funds invested in less 

99    See “Addressing Structural Vulnerabilities from Liquidity Mismatch in Open-Ended Funds – Revisions 

to the FSB’s 2017 Policy Recommendations: Consultation report”, FSB, July 2023. 

100   For a more detailed discussion, see the article entitled “The growing role of investment funds in euro 

area real estate markets: risks and policy considerations”, Macroprudential Bulletin, No 20, ECB, April 
2023. 

101   Under the revised AIFMD and UCITS Directive, if adopted, fund managers should have at least two 
appropriate liquidity management tools in place, which could include suspension of redemptions, 
redemption gates, notice periods, redemption fees, swing pricing, dual pricing, anti-dilution levies, 
redemptions in kind or side pockets. 

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liquid assets.102  However, price-based liquidity management tools could be difficult 
to use in stressed market conditions when liquidity has dried up and price 
information could be missing or distorted. Therefore, to ensure that withdrawals do 
not cause liquidity strains under such conditions, redemption terms should be 
commensurate with asset liquidity. In particular, as discussed above, longer notice 
periods might be warranted for funds investing in less liquid assets, and higher 
liquidity buffers might be needed for funds offering daily redemptions. 

Money market fund (MMF) reforms in the EU should be pursued as a matter of 
priority, in line with the international policy proposals. Following the March 2020 
market turmoil, proposals to enhance the resilience of MMFs without unduly 
curtailing their economic function were developed at both the international and the 
European levels. The proposals focused on removing regulatory threshold effects, 
strengthening MMF liquidity requirements and improving the availability and usability 
of liquidity management tools.103  In the EU, however, reform of MMFs has seen 
limited progress to date. While MMFs will be required to have at least two liquidity 
management tools, as is the case for other funds, no legal reforms have as yet been 
proposed to the dedicated EU Money Market Fund Regulation.104  In the United 
States, the authorities have adopted significant MMF reforms, such as raising 
liquidity requirements to 25% and 50% of a fund’s total assets for daily and weekly 
liquid assets respectively.105  As the United States and other jurisdictions are 
progressing with legal reforms, updating the EU’s MMF framework should be 
pursued as a matter of priority. 

102   The aim of such tools is to impose the cost of redemptions on redeeming investors, thereby ensuring 
that the remaining investors do not have to bear the cost. This can be achieved by adjusting the price 
at which investors buy and sell shares in the fund, for example, or by imposing a redemption fee. 
103   At the international level, see “Policy Proposals to Enhance Money Market Fund Resilience – Final 

report”, Final Report, FSB, October 2021. At the European level, see “Eurosystem contribution to the 
European Securities and Markets Authority (ESMA) consultation on the framework for EU money 
market funds”, ECB, June 2021; “Recommendation of the European Systemic Risk Board of 2 
December 2021 on reform of money market funds”, ESRB, January 2022; and “ESMA opinion on the 
review of the Money Market Fund Regulation”, Final Report, ESMA, February 2022. 

104   See “Report from the Commission to the European Parliament and the Council on the adequacy of 
Regulation (EU) 2017/1131 of the European Parliament and of the Council on money market funds 
from a prudential and economic point of view”, European Commission, July 2023. 

105   On 12 July the US Securities and Exchange Commission (SEC) adopted amendments to certain rules 

that govern MMFs. 

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5.3 

Other ongoing policy initiatives that support euro area 
financial stability 

Topic 

Banking package 

Crisis management 
and deposit insurance 

Crypto-assets 

Digital euro 

Recent initiatives 

Implementation of the latest banking package in the EU, including the final Basel III elements, is currently 
under way. The ECB has published its views on the banking package reforms and welcomes the 
agreement reached by the EU co-legislators on 27 June 2023. This will make it possible to finalise the 
legal process in time to meet the target date for initial application (1 January 2025). The EU 
implementation is in line with the overall objectives of the Basel III framework and will apply to all EU 
banks. The reforms will further bolster the resilience of the banking system, especially by increasing the 
capital needed for credit, operational and market risks. 

Improving the toolkit used to address the failures of smaller and mid-sized banks is at the centre of the 
European Commission’s proposed reform of the crisis management and deposit insurance framework. 
The aim of the reforms is to mitigate risks to financial stability, improve the protection of depositors and 
avert the use of public funds in banking crises by extending the availability of effective crisis management 
options such as transfer tools to a broader set of banks. Loss absorption by shareholders and creditors 
will remain the first line of defence in a bank failure. 

The ECB strongly welcomed the proposal in its opinion. While outside the scope of the Commission’s 
proposal, the ECB noted that a number of further actions are still warranted to strengthen the resilience of 
the European bank crisis management framework: (i) the introduction of a European deposit insurance 
scheme, which would buttress depositor confidence, even in a systemic crisis; (ii) the establishment of a 
common backstop to the Single Resolution Fund, which would bolster the firepower available to support 
bank resolutions in the banking union; and (iii) the introduction of a European backstop for liquidity in 
resolution, which is essential to ensure market confidence in a bank during and after its resolution. 

The regulation of crypto-asset activities is advancing at both European and international levels. In the EU, 
the Markets in Crypto-assets Regulation entered into force in June 2023, containing provisions applicable 
to stablecoins (e-money tokens and asset-referenced tokens as defined by the regulation) from June 
2024 and to other crypto-assets and the provision of crypto-asset services from December 2024. In the 
meantime, the European Banking Authority and the European Markets and Securities Authority are 
consulting on a first set of technical standards to implement the regulation. 

At the international level, the Financial Stability Board (FSB) has published a Global Regulatory 
Framework for Crypto-asset Activities providing high level recommendations for regulating crypto-asset 
activities and markets and global stablecoin arrangements. Implementing these recommendations across 
FSB jurisdictions and beyond will be key to promoting consistency and international cooperation in these 
areas. Furthermore, the IMF-FSB synthesis paper represents an important step forward in the 
implementation process as it brings together regulatory and macro-financial considerations related to 
crypto-assets. It also outlines the next steps international organisations and standard-setting bodies will 
take to implement crypto-asset policy frameworks aimed at addressing macroeconomic and financial 
stability risks. 

On 28 June 2023 the European Commission published its Single Currency Package, comprising a 
legislative proposal for the establishment of the digital euro and a legislative proposal on the legal tender 
of euro cash. The ECB warmly welcomed the proposal settling the legal framework for a possible digital 
euro that would be widely usable and largely available in the digital economy and would complement euro 
banknotes and coins. The legal foundation of the digital form of the euro would also ensure that central 
bank money would continue to contribute significantly to a resilient, efficient and well-functioning payment 
system. The ECB received the consultation requests from the Council of the European Union and the 
European Parliament in September and will publish its opinion within three months. The legislative act is 
expected to be adopted by the end of 2024 at the earliest. 

The two-year investigation phase for the digital euro project concluded in October 2023 when the ECB’s 
Governing Council decided to launch the next phase of the programme, the preparation phase.106 
However, the issuance of a digital euro would require a separate Governing Council decision and would 
be taken only after the legislative act has been adopted. 

Capital markets union  On 24 May 2023 the European Commission published a proposal for a retail investment strategy as part 

of its 2020 Capital Markets Union Action Plan. The aim of the proposal is to enable retail investors to 
make well-informed financial decisions by ensuring that information is provided in a more standardised 
format, by increasing the transparency and comparability of cost structures and by addressing potential 
conflicts of interests (e.g. by not allowing inducements for “execution-only” sales or by protecting retail 
investors from misleading marketing campaigns). A further aim of the Commission’s proposal is to 
implement measures which could reduce administrative burdens and improve the accessibility of 
products and services. In addition, the proposal brings forward measures aimed at enhancing supervisory 
cooperation to ensure consistent implementation throughout the EU. 

106   See also “Eurosystem proceeds to next phase of digital euro project”, press release, ECB, 18 October 

2023. 

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Special features 

A 

Assessing risks from euro area banks’ maturity 
transformation 

Prepared by Lara Coulier, Sándor Gardó, Benjamin Klaus, Francesca 
Lenoci, Cosimo Pancaro and Alessio Reghezza 

This special feature builds on the concept of maturity gap as a metric of banks’ 
maturity mismatch to shed light on how banks’ engagement in maturity 
transformation differs across euro area countries and bank types. Banks can mitigate 
the interest rate risk stemming from their maturity mismatch by using derivatives for 
hedging purposes. Euro area banks increased their positions in interest rate 
derivatives over the last two years in anticipation of the start of monetary policy 
normalisation. Significant institutions rely more than cooperative and savings banks 
on interest rate derivatives and have a more diversified positioning. The extent of 
banks’ maturity mismatch determines the sensitivity of their net interest income to 
changes in interest rates and the slope of the yield curve. This special feature 
provides empirical evidence that the more banks engage in maturity transformation 
the more their net interest margin benefits from a steepening of the yield curve, 
boosting bank profits. This effect might dissipate going forward, especially for banks 
in countries where variable-rate lending predominates. 

Introduction 

Engaging in maturity transformation exposes banks to interest rate risk: the 
potential negative impact on their earnings or capital that could arise from 
adverse changes in interest rates.107  The failure of Silicon Valley Bank in the 
United States in March 2023 illustrates the possible challenges banks can face 
following a swift and material rise in interest rates. This is especially the case when 
compounded by weak risk management practices and business models that feature 
a high share of long-term assets and rely largely on uninsured deposits. 

This special feature builds on the maturity gap, a metric of banks’ maturity 
mismatch, to explore the role of maturity transformation for banks. It first 
examines how banks’ maturity gaps change over time and across bank types before 
going on to discuss the role that interest rate derivatives can play in mitigating the 
interest rate risk stemming from maturity mismatch. Finally, it investigates the 
implications of the maturity gap for banks’ net interest margins (NIMs). 

107   Changes in interest rates affect banks’ interest-sensitive income and expenses and, over time, their 
profitability. Changes also have an immediate impact on the value of a bank’s assets and liabilities 
through changes in the present value and the timing of future cash flows. The bank’s economic value of 
equity is also affected accordingly. While banks’ aggregate profitability benefits from rising interest rates 
and a steepening yield curve, their economic value of equity is likely to be negatively affected. 

Financial Stability Review, November 2023 – Special features 

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Maturity transformation and interest rate risk 

Banks’ engagement in maturity transformation can be measured by the 
maturity gap. The maturity gap captures the difference between the repricing period 
for bank assets and bank liabilities. Due to data availability constraints, in this special 
feature the maturity gap is approximated by the difference between the weighted 
average repricing period for loans to the non-financial private sector and the 
weighted average repricing period for deposits from the non-financial private sector, 
based on new business volumes.108  A positive maturity gap indicates that loan 
repricing occurs over a longer timespan than deposit repricing. This measure makes 
it possible to analyse the relations between banks’ balance sheet structures and 
interest rate developments, and the implications for profitability. 

The aggregate maturity gap of euro area banks has decreased during the 
recent rate-hiking cycle. During the period of ultra-low interest rates which ran from 
2014 to 2021, the average time for loans to reprice increased gradually (Chart A.1, 
panel a) as the share of fixed-rate lending rose (Chart A.1, panel b). Banks had an 
incentive to earn the larger term premium associated with longer maturities to 
partially offset margin compression and the related drop in profitability. Also, 
customers preferred to borrow at fixed rates with a view to locking in very low rates 
for a longer period. At the same time, there was a decline in the average time for 
deposits to reprice on account of the shift from term deposits to overnight 
deposits.109  As a result, the average maturity gap rose to about 35 months as at the 
end of the last quarter of 2021 (Chart A.1, panel a). This trend then reversed as 
expectations of monetary policy tightening began to materialise. The decrease in the 
maturity gap was driven by a reduction in loan repricing time, caused by a drop in the 
share of fixed-rate lending, as well as an increase in deposit repricing time. The latter 
was caused by a shift from overnight deposits to term deposits on the back of the 
higher remuneration provided by the latter when rates are rising. 

108   The definition of maturity gap follows the approach used by Altavilla, C., Boucinha, M. and Peydró, J.-

L., “Monetary policy and bank profitability in a low interest rate environment”, Economic Policy, Vol. 33, 
Issue 96, 2018, pp. 531-586. One caveat is that the data used to calculate the maturity gap provide 
information on the contractual time to reprice and do not account for behavioural assumptions. This is 
especially relevant for the calculation of the effective time for mortgages and overnight deposits to 
reprice as contractual repricing does not account for loan prepayments and/or the fact that the 
behavioural repricing of overnight deposits is longer than the contractual repricing. Similar measures, 
covering banks’ full balance sheets, are used by English, W., Van den Heuvel, S. and Zakrajšek, E., 
“Interest rate risk and bank equity valuations”, Journal of Monetary Economics, Vol. 98, Issue C, 2018, 
pp. 80-97, and Drechsler, I., Savov, A. and Schnabl, P., “Banking on Deposits: Maturity Transformation 
without Interest Rate Risk”, Journal of Finance, Vol. 76, Issue 3, 2021, pp. 1091-1143. 
109   For more details, see the box entitled “Euro area bank deposit costs in a rising interest rate 

environment”, Financial Stability Review, ECB, May 2023. 

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Chart A.1 
The growing share of variable-rate assets and term deposits has led to a decrease in 
the maturity gaps of euro area banks since the start of the hiking cycle in mid-2022 

a) Maturity gap and time for loans and 
deposits to reprice 

b) Characteristics of lending to households 
for house purchase and NFCs 

(Q1 2011-Q2 2023, months) 

(Jan. 2015-July 2023, percentages) 

Sources: ECB (iMIR, MIR) and ECB calculations. 
Notes: The dashed grey lines mark the start of the hiking cycle in July 2022. Panel a: based on an unbalanced sample of 330 
monetary financial institutions (MFIs, consolidated). The lines represent the median in each quarter. Panel b: loans include new 
lending for house purchase (households) and new loans other than revolving loans and overdrafts, convenience and credit card debt 
extended to non-financial corporations (NFCs). 

Banks’ maturity gaps differ across countries and bank types due to 
differences in interest rate fixation conventions and business model 
characteristics. In terms of their maturity gaps, banks domiciled in euro area 
countries can be clustered into three groups: around ten months, about 30 months 
and above 40 months (Chart A.2, panel a). The gap is higher in countries where 
banks have a larger share of long-term, fixed-rate loans. Typically, long-term loans 
originated at a fixed rate have a higher duration and are therefore more sensitive to 
interest rate risk. When it comes to bank types, cooperative banks and savings 
banks are more active in maturity transformation (Chart A.2, panel b), given their 
focus on traditional banking activities with a greater share of long-term loans to 
households and NFCs (Chart A.2, panel c).110  By contrast, significant institutions’ 
more diversified business models have a narrower maturity gap (Chart A.2, panel b), 
mainly because they carry a lower share of long-term loans on their balance sheets. 

110   Cooperative and savings banks are defined based on the field specialisation provided by BvD 

Electronic Publishing GmbH – a Moody’s Analytics company and are validated at the country level 
using data from the European Association of Co-operative Banks and the European Savings and Retail 
Banking Group. Significant institutions reflect the list of euro area banks supervised by the ECB and 
are reclassified as either cooperative banks or savings banks if BvD Electronic Publishing GmbH – a 
Moody’s Analytics company considers their business model to be attributable to these specialisations. 
Banks’ balance sheets are captured at the highest level of consolidation, where available. This sample 
of banks consists of 81 significant institutions, 1,403 cooperative banks and 407 savings banks, 
covering €19 trillion, €8 trillion, and €2.6 trillion of total assets at year-end 2022 respectively. However, 
data on time for loans and deposits to reprice are more limited. iMIR covers only 55 significant 
institutions, 23 cooperative banks and 21 savings banks, representing 85%, 44% and 34% of the 
starting sample in terms of total assets respectively. 67 significant institutions, 395 cooperative banks 
and 341 savings banks report under EMIR and they account for 97%, 90% and 93% of the starting 
sample in terms of total assets respectively. 

Financial Stability Review, November 2023 – Special features 

96 

0.00.10.20.30.40.50.60.70.80.905101520253035404520112014201720202023Maturity gapMedian repricing of loansMedian repricing of deposits (right-hand scale)2527293133353739414345121416182022242620152017201920212023Share of fixed-rate loans in new loans to households and NFCs (right-hand scale)Share of new lending to households and NFCs with maturities beyond ten years 
 
 
 
 
Chart A.2 
Banks’ maturity gaps vary across euro area countries and banks’ business models 

a) Average maturity gap and 
share of long-term loans 
across the euro area 

b) Median maturity gap, by 
bank type 

c) Breakdown of the loan 
book by average time to 
reprice and bank type   

(Q2 2023, months, percentages) 

(Q1 2011-Q3 2023, months) 

(Q2 2023, percentages) 

Sources: ECB (iMIR), BvD Electronic Publishing GmbH – a Moody’s Analytics company and ECB calculations. 
Notes: Panel a: based on an unbalanced sample of 251 MFIs (consolidated). Panel b: the dashed grey line marks the start of the 
hiking cycle in July 2022. Panels b and c: based on an unbalanced sample of 103 MFIs at the highest level of consolidation.   

Use of derivatives to manage interest rate risk 

Banks can manage their interest rate risk either by changing the composition 
of their balance sheets or by actively using derivatives for hedging purposes. 
The first approach, known as natural hedging, involves aligning the interest rate 
sensitivity of assets and liabilities. In this way, banks’ cash flows generated from 
asset exposures offset those stemming from their liabilities along the repricing 
schedule. Alternatively, banks can use derivatives contracts linked to interest rate 
fluctuations to reduce the duration gap between assets and liabilities without altering 
their balance sheet structures. This means that banks actively trade in the interest 
rate derivatives market to manage their interest rate risk.111 

Euro area banks have increased their positions in interest rate derivatives over 
the last two years. The gross notional traded on EURIBOR interest rate swaps 
(IRS) and forward rate agreements (FRA) by euro area counterparties rose 
significantly between September 2021 and June 2023.112  The bulk of this increase 
took place after the ECB announced the end of net purchases under its pandemic 
emergency purchase programme but before the actual start of the hiking cycle.113 

111   See the boxes entitled “Interest rate risk exposures and hedging of euro area banks’ banking books”, 

Financial Stability Review, ECB, May 2022, and “Euro area interest rate swaps market and risk-sharing 
across sectors”, Financial Stability Review, ECB, November 2022. 

112   EURIBOR IRSs and FRAs are the most traded and liquid derivatives used to manage interest rate risk 
for euro-denominated exposures. Together they accounted for around three-quarters of the gross 
notional derivatives outstanding in the euro area as at mid-2023. 

113   Longer-term market rates had already started rising in this period as expectations for future interest 

rate hikes began to strengthen. 

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97 

0204060LVGRFICYLTEEMTIEESPTATBEITEALUHRSKNLDEFRSIMaturity gapShare of loans with an initial rate fixation in excess of 5 years5152535455565752011201320152017201920212023Significant institutionsCooperative banksSavings banks0102030405060708090100SignificantinstitutionsCooperativebanksSavingsbanksLoans below 1 yearLoans between 1 and 5 yearsLoans above 5 years 
 
 
 
 
 
This might reflect the positioning on interest rate derivatives adopted by banks and 
other informed investors in anticipation of the start of monetary policy normalisation. 
Significant institutions and savings banks increased their interest rate derivatives 
positions substantially during this period, although their greater reliance on 
derivatives was not sufficient to compensate for the material increase in interest rate 
risk (Box A). The overall positioning of cooperative banks remained broadly 
unchanged, but their mix of instruments shifted towards interest rate derivatives with 
longer maturities (Chart A.3, panel a). Similarly, savings banks tend to trade 
derivatives contracts with longer maturities, reflecting their greater maturity 
transformation. 

Chart A.3 
Banks’ net exposures to interest rate derivatives have increased, and cooperatives 
have shifted their instrument mix towards longer maturities since rate hikes started 

a) Net absolute notional in EURIBOR IRSs and FRAs, by bank 
type   

b) Gross notional outstanding 
in EURIBOR IRS and FRAs of 
cooperative and savings 
banks with other euro area 
banks 

(percentage of total assets) 

(June 2023, € billions) 

Sources: BvD Electronic Publishing GmbH – a Moody’s Analytics company, ECB (iMIR, EMIR, RIAD) and ECB calculations. 
Notes: Panel a: at the end of each period, the absolute value of contracts netted at the counterparty and the maturity level is divided 
by the total assets of banks belonging to each specialisation group. The net absolute notional is defined as the absolute value of the 
difference between buying and selling positions on EURIBOR IRSs and FRAs, irrespective of whether counterparties are active in 
EURIBOR IRSs and FRAs, in each of the maturity buckets “Up to 1 year”, “Over 1 and up to 5 years” and “Over 5 years”. Panel b: 
“Intragroup” refers to interest rate derivatives positions among banks identified at solo level and belonging to the same group. 

Significant institutions tend to rely on interest rate derivatives to a larger 
extent than cooperative and savings banks. Their somewhat greater reliance on 
interest rate derivatives may be linked to their ability to leverage more sophisticated 
risk management frameworks.114  Cooperative and savings banks affiliated with 
central cooperative or savings banks (CCBs) frequently enter the derivatives market 
indirectly by trading with their parent, which often nets positions across subsidiaries 
to hedge the resulting bundled trades (Chart A.3, panel b). The benefits arising from 

114   See Esposito, L., Nobili, A. and Ropele, T., “The management of interest rate risk during the crisis: 

Evidence from Italian banks”, Journal of Banking & Finance, Vol. 59, Issue C, 2015, pp. 486-504, and 
Purnanandam, A., “Interest rate derivatives at commercial banks: An empirical investigation”, Journal of 
Monetary Economics, Vol. 54, Issue 6, 2007, pp. 1769-1808. 

Financial Stability Review, November 2023 – Special features 

98 

2.73.81.06.72.91.73.42.03.44.22.84.02.92.44.43.93.06.40246810121416SignificantinstitutionsCooperativebanksSavingsbanksSignificantinstitutionsCooperativebanksSavingsbanksSeptember 2021June 2023Up to 1 yearOver 1 and up to 5 yearsOver 5 years02004006008001,0001,200OtherbanksIntra-groupOtherbanksIntra-groupCooperativebanksSavings banksThousandsDifferent countriesSame country 
 
 
 
 
exploiting offsetting positions might, however, leave the CCB with some interest rate 
risk if the hedge is not perfect. 

The use of interest rate derivatives differs by bank type, with large banks’ 
positionings being more mixed. The net directional positioning in interest rate 
derivatives differs more among significant institutions than among cooperative banks 
and savings banks (Chart A.4).115  The positioning of significant institutions, as either 
net buyers or net sellers, might reflect the diversity of their duration gaps.116  In 
addition, some large banks could also be active in this market with the aim of 
speculating on interest rate movements or acting as market-makers or clearing 
members. Cooperative and savings banks mostly enter the interest rate derivatives 
market as net buyers of EURIBOR IRSs and FRAs.117  Only a few such banks are 
net sellers, and the extent of net sales is limited to less than 2% of their total assets 
(Chart A.4). This suggests that these banks, along with their wider maturity gap, use 
interest rate derivatives mostly for hedging purposes.   

Chart A.4 
Significant institutions exhibit more diverse interest rate derivatives positions 

Distribution of net notional outstanding on EURIBOR IRSs and FRAs over total assets 

(Q4 2018-Q3 2023, percentages) 

Sources: BvD Electronic Publishing GmbH – a Moody’s Analytics company, ECB (iMIR, EMIR) and ECB calculations. 
Notes: See notes to Chart A.3. For the number of banks included in each specialisation group, see footnote 110. Bars show the 
interquartile ranges while whiskers are winsorised at the 10th and 90th percentiles. Positive (negative) values indicate net buyers 
(sellers), i.e. notional values on pay-fix receive-float positions are larger (smaller) than pay-float receive-fix positions. 

Impact of maturity transformation on bank net interest margins 

Bank profitability generally benefits from rising interest rates. In the current 
context of rising interest rates, euro area banks’ net interest margins increased from 

115   The directional positioning in interest rate derivatives is proxied by the ratio of net notional on 

EURIBOR IRSs and FRAs to banks’ total assets. 

116   Banks with a positive duration gap can hedge their exposures by taking positions in IRSs as net 

buyers, while banks with a negative duration gap can hedge their exposures by acting as net sellers. 
On average, banks are net buyers while insurance companies and pension funds are net sellers. 
Market-makers are the main counterparty of banks. 

117   Banks, which are net buyers, have long positions and their cash flow results from paying the fixed-rate 

EURIBOR and receiving the floating-rate EURIBOR. 

Financial Stability Review, November 2023 – Special features 

99 

-10-50510152018-202021-2220232018-202021-2220232018-202021-222023Significant institutionsCooperative banksSavings banksInterquartile ranges (net notional/total assets)Median 
 
   
 
their recent minimum of 1.2% in the third quarter of 2021 to 1.5% in the second 
quarter of 2023, benefiting from the widening of the loan-deposit margin (Chart A.5, 
panel a). Indeed, changes in the level of interest rates and the slope of the yield 
curve can affect banks’ net interest margins. An increase in interest rates may 
improve banks’ NIMs in line with the “retail deposits endowment effect”, according to 
which overnight deposit rates are priced at a markdown on market rates and tend to 
be sticky upwards.118  Since retail deposits represent the largest component of bank 
liabilities, an increase in interest rates results in improved NIMs as assets reprice or 
mature faster than liabilities. A change in the shape of the yield curve could also 
affect banks’ NIMs. Since banks engage in maturity transformation, a steepening of 
the yield curve may provide more of a boost to longer-term yields than to short-term 
yields, raising the rate on interest-earning assets more than the cost of liabilities. 

Chart A.5 
Higher short-term interest rates and a steeper yield curve have, on average, a 
positive impact on euro area banks’ margins 

a) NIM and loan-deposit margin on 
outstanding volumes 

b) Estimated NIM impact of an increase in the 
short-term rate and the slope of the yield 
curve 

(Q1 2016-Q2 2023; percentage points, percentages) 

(basis points) 

Sources: BvD Electronic Publishing GmbH – a Moody’s Analytics company, LSEG, ECB (iMIR, supervisory data) and ECB 
calculations. 
Notes: Panel a: the dashed grey line marks the start of the hiking cycle in July 2022. The net interest margin is defined as net interest 
income divided by total earning assets. The interest rate spread (loan-deposit margin) is calculated as the difference between the 
weighted average rate on outstanding loans to non-financial corporations (NFCs) and households and the weighted average rate on 
outstanding deposits from NFCs and households using the outstanding amounts as weights. Panel b: the blue dots represent the point 
estimates, while the dashed yellow lines show the 90% confidence bands. The sample period runs from Q4 2014 to Q2 2023. The 
slope is calculated as the difference between the yields on government bonds with a residual maturity of ten years and two years. The 
regressions control for a wide range of bank-specific characteristics such as the logarithm of total assets, the CET1 ratio, the ratio of 
liquid assets to total assets, the cost/income ratio, the ratio of risk-weighted assets to total assets, the ratio of loans to total assets, the 
ratio of deposits to total assets and macro-level controls such as annual GDP growth and inflation. The regressions are saturated with 
bank fixed effects and standard errors are clustered at the bank level. The regressions are estimated on a balanced sample of 122 
significant institutions and less significant institutions. The estimated impact represents the effect of a 1 percentage point increase in 
the three-month OIS rate and a 1 percentage point increase in the country-specific slope of the yield curve. 

The empirical evidence confirms that an increase in short-term rates and a 
steepening of the yield curve support bank margins. Bank-level estimations, 

118   See Albertazzi, U. and Gambacorta, L., “Bank profitability and the business cycle”, Journal of Financial 
Stability, Vol. 5, 2009, pp. 393-409; Alessandri, P. and Nelson, B.N., “Simple banking: Profitability and 
the yield curve”, Journal of Money, Credit and Banking, Vol. 47, 2015, pp. 143-175; Borio, C., 
Gambacorta, L. and Hofmann, B., “The influence of monetary policy on bank profitability”, International 
Finance, Vol. 20, 2017, pp. 48-63; and English, W.B., Van den Heuvel, S.J. and Zakrajšek, E., “Interest 
rate risk and bank equity valuation”, Journal of Monetary Economics, Vol. 98, 2018, pp. 80-97. 

Financial Stability Review, November 2023 – Special features 

100 

1.101.151.201.251.301.351.401.451.501.551.601.51.61.71.81.92.02.12.22.32.42.52016201820202022Interest rate spread on outstanding volumesNet interest margin (right-hand scale)02468103-month OIS rateSlope of the yield curve 
 
 
 
 
regressing the NIM on the level of the short-term rate and the slope of the yield curve 
while controlling for a large set of bank- and country-specific characteristics, confirm 
the empirical evidence in the literature. At impact there is a positive and statistically 
significant relationship between NIM and both the level of the short-term rate and the 
slope of the yield curve (Chart A.5, panel b). More specifically, the estimated 
coefficients suggest that a 1 percentage point increase in the three-month overnight 
index swap (OIS) rate increases the NIM by 4.8 basis points, while a 1 percentage 
point increase in the slope of the yield curve has a positive impact of 5.8 basis 
points.119  The estimated coefficients do not capture longer-term effects, which could 
differ from the results at impact once the liability repricing catches up and credit risk 
may arise. 

Chart A.6 
The impact of higher short-term interest rates and a steeper yield curve on bank 
margins varies with the extent of maturity transformation and across bank types 

a) Differential estimated impact on the NIM for 
banks with higher maturity gaps 

b) Differential estimated impact on the NIM for 
cooperative and savings banks versus 
significant institutions 

(basis points) 

(basis points) 

Sources: BvD Electronic Publishing GmbH – a Moody’s Analytics company, LSEG, ECB (iMIR, supervisory data) and ECB 
calculations. 
Notes: The blue dots represent the point estimates, while the dashed yellow lines show the 90% confidence bands. For details on the 
sample period and included variables, see notes under Chart A.5. The regressions are saturated with bank and time fixed effects and 
standard errors are clustered at the bank level. Panel a: regressions are estimated on a balanced sample of 122 significant institutions 
and less significant institutions. The estimated impact represents the differential effect of a 1 percentage point increase in the three-
month OIS rate and a 1 percentage point increase in the country-specific slope of the yield curve for a bank with a maturity gap that is 
one standard deviation above the sample average. Panel b: regressions are estimated on a balanced sample of 48 significant 
institutions and 42 cooperative and savings banks. The estimated impact represents the differential effect of a 1 percentage point 
increase in the three-month OIS rate and a 1 percentage point increase in the country-specific slope of the yield curve for cooperative 
and savings banks compared with significant institutions. 

Banks with a wider maturity gap benefit less from a change in short-term rates 
and more from a steepening of the yield curve. The empirical evidence also 
shows that a higher maturity gap has a significantly negative impact on the 
relationship between the NIM and the short-term rate (Chart A.6, panel a). A bank 
with a maturity gap that is one standard deviation above the sample average exhibits 
an increase in its NIM that is 1 basis point smaller in response to a 1 percentage 

119   This result is confirmed by several studies, including Samuelson, P.A., “The effect of interest rate 

increases on the banking system”, American Economic Review, Vol. 35, 1945, pp.16-27; English, W.B., 
“Interest rate risk and bank net interest margins”, BIS Quarterly Review, BIS, December 2002; and 
Claessens, S., Coleman, N.C. and Donnelly, M., “‘Low-for-long’ interest rates and banks’ interest 
margins and profitability: Cross-country evidence”, Journal of Financial Intermediation, Vol. 35, 2017, 
pp. 1-16. 

Financial Stability Review, November 2023 – Special features 

101 

-2-101234563-month OIS rate * maturitygap (sd)Slope of the yield curve *maturity gap (sd)-2024681012143-month OIS rate *cooperative and savingsbanksSlope of the yield curve *cooperative and savingsbanks 
 
 
 
 
point increase in the short-term rate.120  This is consistent with the view that banks 
with a larger mismatch between the repricing schedules of their assets and their 
liabilities will benefit less from parallel shifts in interest rates. This is because, all else 
equal, their liabilities reprice faster than banks with a narrower mismatch, leading to 
a smaller increase in margins. By contrast, a higher maturity gap has a positive and 
statistically significant impact on the relationship between the NIM and the slope of 
the yield curve (Chart A.6, panel a). A bank with a maturity gap that is one standard 
deviation above the sample average exhibits an increase in its NIM that is 2.5 basis 
points stronger in response to a 1 percentage point steepening of the yield curve 
compared with a bank with a maturity gap at the sample average. Indeed, banks 
engaging in maturity transformation benefit more from a steepening of the yield 
curve which, by raising long-term yields more than short-term yields, induces a 
greater increase in interest-earning assets than interest-bearing liabilities for these 
banks. 

The margins of cooperative and savings banks gain more from a steepening of 
the yield curve than significant institutions’ margins. As cooperative and savings 
banks engage more in maturity transformation than significant institutions (Chart 
A.2, panels b and c), the NIMs of these banks benefit more from a steepening of the 
yield curve (Chart A.6, panel b). More specifically, the NIMs of savings and 
cooperative banks increase by 6.9 basis points more than the NIMs of significant 
institutions in response to a 1 percentage point increase in the slope of the yield 
curve. The effect of an increase in the short-term rate is not found to be significantly 
different for the various types of banks. 

Conclusions 

The extent to which bank margins benefit from higher interest rates depends 
on the maturity mismatch between their assets and their liabilities. The maturity 
gap, a measure of maturity mismatch, started to decline at the end of 2021. The 
maturity gap differs across euro area countries and bank types, depending on 
country-level interest rate fixation conventions and bank business model 
characteristics. Cooperative and savings banks appear to have a larger maturity gap 
than significant institutions owing to their more diversified business models. 

Banks with longer asset duration managed to sustain margins better during 
the period of ultra-low interest rates but may experience only a delayed 
positive impact from higher rates. Euro area banks’ NIMs were compressed for 
several years during the period of ultra-low interest rates when banks sustained their 
profitability by extending loans with longer maturities and collecting the term 
premium. Customers, for their part, took the opportunity to lock in historically low 
interest rates over an extended period. However, the loans granted at that time with 
long interest rate fixation periods offer limited potential for benefiting from higher 
rates, as such assets are repriced at a slower pace. At the same time, higher interest 
rates make the funding of legacy long-term, fixed-rate assets increasingly 

120   On average, the maturity gap in the sample is 40 months while the standard deviation is 31 months. 

Financial Stability Review, November 2023 – Special features 

102 

 
 
 
challenging. As such, while rising interest rates impact banks’ margins positively 
overall, the profitability of significant institutions, which are characterised by a higher 
share of variable-rate lending, has benefited more from the recent fast increase in 
interest rates. 

Banks have started to adjust their balance sheets and hedging practices as 
expectations of monetary policy tightening begin to materialise. With the start 
of monetary policy normalisation, banks have in aggregate increased their reliance 
on interest rate derivatives. Less sophisticated banks, such as cooperative and 
savings banks, have larger maturity gaps but do not use interest rate derivatives as 
much as their larger peers do. Significant institutions are more varied in their interest 
rate derivatives positionings, possibly reflecting more diverse duration gaps, their 
role as clearing members or market-makers, or speculative behaviour. Significant 
institutions and savings banks have significantly increased their interest rate 
derivatives positioning since September 2021. The overall positioning of cooperative 
banks has remained largely unchanged, but their mix of instruments has shifted 
towards interest rate derivatives with longer maturities. 

Box A 
How is the banking sector coping with increased interest rate risk? 

Prepared by Marcel Bräutigam, Rasmus Pank Roulund, Gernot Stania, and Nina Stizi 

Uncertainty over the future path of interest rates exposes banks to interest rate risk. The 
usual maturity mismatch between bank assets and liabilities means that banks are exposed to 
interest rate risk. Banks can mitigate this risk by using interest rate swaps and other interest rate 
derivatives. As the extent to which banks hedge interest rate risk is a key determinant of the 
resilience of credit intermediation to shocks in the yield curve, their interest rate risk management 
matters for financial stability. 

This box uses supervisory and market data to examine how effectively banks use interest 
rate derivatives to mitigate interest rate risk. The impact of changes in the yield curve on the 
economic capital of a bank can be measured as the change in the bank’s economic value of equity 
(EVE) – defined as the net present value of future expected cash flows. Quarterly supervisory 
data121  can be used to infer bank-level sensitivities122  of EVE to yield curve shocks. Building an 
EVE risk distribution at the level of individual banks also requires a probability distribution of future 
changes to the yield curve. This can be constructed from two types of market data that are available 
on a daily basis: the EUR yield curve and the corresponding implied swaption volatilities for the 
different tenors of the curve. After aggregation across banks, the standard deviation of the resulting 
EVE risk distribution is used as a measure of system-level interest rate risk. 

Compared with 2021, the effectiveness with which banks hedge interest rate risk has 
declined as the risk level has increased. Leveraging a breakdown of the data provided by the 
ECB’s Short Term Exercise (STE) into derivative and non-derivative positions makes it possible to 
calculate the hypothetical interest rate risk while excluding derivatives and the portion of interest 

121   These data are part of the STE conducted by the ECB for the purposes of the Supervisory Review and 

Evaluation Process (SREP). 

122   The sensitivity contribution of non-maturity deposits is based on banks’ internal models subject to STE 

reporting instructions. 

Financial Stability Review, November 2023 – Special features 

103 

 
 
 
rate risk hedged by derivatives. Elevated uncertainty regarding the path of interest rates reflected 
by swaption volatilities, together with longer bank asset maturities, drove the exposure of euro area 
banks to interest rate risk to a peak in the third quarter of 2022 (Chart A, panel a). Swaption 
volatilities have increased significantly across all tenors of the yield curve since 2021 (Chart A, 
panel b). At the same time, the duration of banks’ non-derivative banking book positions has 
increased by about 35%. In line with earlier findings, derivatives have a mitigating effect (i.e. the 
hedged portion is positive).123  However, this mitigating effect has not been sufficient to 
counterbalance the two drivers of increased interest rate risk (Chart A, panel a). 

Chart A 
Interest rate risk and swaption volatilities have increased markedly since 2021, while banks’ 
hedging effectiveness has declined 

a) Hedged and unhedged interest rate risk in the euro 
area 

b) Swaption volatilities for the euro 

(Q1 2021-Q2 2023; € billions) 

(maturity in years, basis points) 

Sources: ECB (supervisory data), Bloomberg Finance L.P. and ECB calculations. 
Notes: Panel a: the change in interest rate risk is calculated on the basis of the euro-denominated banking book positions of a panel of 89 banks. Each bank 
reports a repricing ladder for its assets, liabilities and derivatives. This is a breakdown by the earliest time at which the interest rate of a given position might 
be reset. Percentages inside bars indicate remaining risk, i.e. the share of interest rate risk not mitigated with interest rate derivatives. Panel b: volatilities 
implied by prices of swaptions with an expiry in one year for the period 2021-23. 

Banks’ hedging has served first and foremost to avoid profit and loss swings due to fair 
value accounting rather than to mitigate interest rate risk in the banking book (IRRBB) more 
effectively. Under the International Financial Reporting Standards, interest rate changes only have 
an immediate impact on income or capital for positions carried at fair value. Banks can use fair 
value hedges to offset corresponding revaluation impacts, which has been the strategy for hedging 
interest rate risk adopted by euro area banks (Chart B, panel a). The banking book consists of 
positions held at fair value and positions held at amortised cost: the latter include mortgages and 
contribute more to IRRBB (Chart B, panel b), but have generally not been hedged with derivatives 
(Chart B, panel a). 

123   See the box entitled “Interest rate risk exposures and hedging of euro area banks’ banking books”, 

Financial Stability Review, ECB, May 2022. 

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104 

45%49%51%32%48%51%59%57%55%63%0102030405060708090Q12021Q22021Q32021Q42021Q12022Q22022Q32022Q42022Q12023Q22023Hedged interest rate riskUnhedged interest rate risk020406080100120140160180051015202530Q1 2021Q3 2022Q2 2023 
 
 
 
 
Chart B 
In the euro area, positions carried at amortised cost that contribute more to IRRBB than fair value 
positions have generally not been hedged with derivatives 

a) Contribution of hedging derivatives to duration 
gap 

b) Contribution of selected balance sheet items to 
duration gap 

(years) 

(years) 

Sources: EBA and ECB calculations.   
Notes: Panel a: the chart shows the impact of hedging instruments on the overall duration gap. Panel b: the chart shows the impact of selected balance sheet 
items on the overall duration gap. The impact is determined by excluding the item and comparing it with the full duration gap. The boxes represent the 25-75th 
interquartile range, the whiskers denote the 10-90th percentile, and the yellow line denotes the median. “Sec.” stands for securities; “Deriv.” stands for 
derivatives. 

The interest rate risk of euro area banks remains elevated and is only partly hedged. Despite 
subsiding slightly since its peak in the third quarter of 2022, interest rate risk remains elevated. In 
addition, less than half of the exposure has been effectively hedged. Adverse changes to the yield 
curve could therefore reduce the economic capital of the banking sector, particularly if these shocks 
were to persist. 

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105 

-101Cash flowhedgingCross-currencyhedgingEconomichedgingFair valuehedgingMedian across banksInterquartile range10-90th percentile-5-4-3-2-101234Sec.MortgagesOtherSec.DepositsAssetsLiabilitiesDeriv.Median across banksInterquartile range10-90th percentile 
 
 
 
 
 
 
 
B 

Real estate markets in an environment of high financing 
costs 

Prepared by Ellen Ryan, Barbara Jarmulska, Giorgia De Nora, Adele 
Fontana, Aoife Horan, Jan Hannes Lang, Marco Lo Duca, Claudiu 
Moldovan and Marek Rusnák 

Tighter financing conditions have reduced the affordability of and demand for real 
estate assets, putting downward pressure on prices. They have also increased the 
debt service costs faced by existing borrowers, with more-indebted borrowers in 
countries with widespread variable-rate lending being the most affected. Robust 
labour markets have thus far supported household balance sheets, thereby 
mitigating credit risk in banks’ relatively large residential real estate exposures. 
Commercial real estate firms, by contrast, have faced more severe challenges in a 
context of rising financing costs and declining profitability. While banks have smaller 
exposures to commercial real estate markets, losses in this segment could act as an 
amplifying factor in the event of a wider shock. 

Introduction 

Imbalances in real estate markets can cause financial crises, as has been seen 
several times in the past. The 2008 global financial crisis is the most prominent 
example of the financial and macroeconomic instability caused by credit-fuelled real 
estate boom-bust cycles. The importance of real estate markets for financial stability 
stems from the strong link between the real estate sector and significant parts of the 
economy, including the banking sector.124   

Real estate markets in the euro area have received closer attention due to their 
dynamism in recent years.125  This dynamism has been the result of both cyclical 
forces and structural changes such as the shift to e-commerce and hybrid working, 
leading to the accumulation of significant vulnerabilities in euro area real estate 
markets.126  Residential real estate (RRE) and commercial real estate (CRE) entered 
a downturn in mid-2022, in the case of RRE after a decade-long boom (Chart B.1, 
panel a) and in the case of CRE after a brief post-pandemic recovery (Chart B.1, 
panel b). These developments call for an assessment of the conditions and channels 
which could lead to risk materialisation and broader financial instability in an 
environment of high interest rates. 

124   See the article entitled “Real estate markets, financial stability and macroprudential policy”, 

Macroprudential Bulletin, No 19, ECB, 2022. 

125   See the section entitled “Vulnerable real estate markets are turning”, Financial Stability Review, ECB, 

May 2023. 

126   Those vulnerabilities relate in particular to real estate price overvaluation and accumulated 

indebtedness collateralised by real estate, or by real estate firms.   

Financial Stability Review, November 2023 – Special features 

106 

 
 
 
Chart B.1 
As RRE and CRE markets enter a downturn, losses could materialise in the financial 
system 

a) Consumer sentiment in 
housing markets   

b) Investor views on the CRE 
cycle   

c) Bank exposures to RRE 
and CRE 

(Q1 1999-Q3 2023 intention to buy a 
house, Q4 2002-Q2 2023 housing market 
prospects; net percentages ) 

(Q2 2015-Q2 2023, percentages of 
investors surveyed ) 

(Q4 2022, percentages of total loans and 
advances)   

Sources: Panel a: ECB (BLS, European Commission). Panel b: RICS, ECB and ECB calculations. Panel c: ECB (supervisory data). 
Notes: Panel a: the ECB’s bank lending survey (BLS) shows what net percentage of banks report that housing market prospects 
contribute to an increase (+) or a decrease (-) in mortgage loan demand. A negative reading therefore implies many banks reporting 
that the current housing market prospects are putting a drag on loan demand. Hence, an indirect connection between the BLS results 
and housing market prospects can be inferred. 

Real estate price corrections and borrowers’ impaired debt servicing capacity 
related to high financing costs could lead to bank losses (Figure B.1). Rising 
interest rates reduce the affordability of and demand for real estate assets. This 
pushes down real estate prices and exposes banks to losses where real estate 
assets are used as collateral – by increasing banks’ losses given default (LGDs).127 
At the same time, rising interest rates push up financing costs via higher debt service 
costs, and this increases the probability of default (PD), particularly where borrowers 
face income challenges. Bank losses can be significant and widespread when LGDs 
and PDs increase in tandem, which has systemic implications. This special feature 
discusses first how price and collateral channels affect LGDs and then how the cost 
of borrowing and income impact PDs. 

127   Indirectly, a fall in house prices can also have negative implications for household consumption via 

wealth effects or confidence and can reduce access to credit for firms that use real estate as collateral 
(see, for example, Horan, A., Jarmulska, B. and Ryan, E., “Asset prices, collateral and bank lending: 
the case of Covid-19 and real estate”, Working Paper Series, No 2823, ECB, 2023). 

Financial Stability Review, November 2023 – Special features 

107 

-88-86-84-82-80-78-76-74-80-60-40-20020401999200120032005200720092011201320152017201920212023Intention to buy a house (right-hand scale)Housing market prospects010203040506070809010006/1503/1612/1609/1706/1803/1912/1909/2006/2103/2212/22Upswing PeakDownturnBottom 01020304050607080EEMTLTLVCYSKNLBEFIPTDEIEBGESSIATGRITHRLUFREARRE loansCRE loans 
 
 
 
 
 
Figure B.1 
A combination of rising financing costs, falling real estate prices and negative income 
shocks for households and real estate firms could lead to banking sector losses 

While the current environment places greater pressure on banks’ CRE 
exposures, these exposures are less systemically important than their RRE 
portfolios. Both CRE and RRE markets are in a downturn and existing borrowers 
are faced with higher debt service costs amid high interest rates. While mortgage 
borrowers’ debt servicing capacity is currently supported by robust labour markets, 
CRE borrowers face declining profitability. This exposes CRE portfolios to a higher 
likelihood of facing debt servicing challenges. Banks’ RRE exposures are large, with 
residential mortgages accounting in aggregate for almost 30% of euro area banks’ 
total loans. By contrast, banks have around 10% of loans exposed to CRE (Chart 
B.1, panel c).128,129  While the relatively limited size of bank CRE portfolios implies 
that they are unlikely on their own to lead to a systemic crisis, they could play a 
significant amplifying role in the event of broader market stress. 

128   This figure uses exposures collateralised by CRE as a simple proxy for banks’ exposures to CRE. In 

some cases, this approach will also capture loans with a purpose other than CRE, but which use CRE 
collateral, and may also miss some CRE-purposed loans which use non-CRE collateral. However, this 
simple approach allows for a clear comparison with RRE portfolios. For more detail on types of 
exposure to CRE among euro area banks, see the article entitled “Commercial real estate and financial 
stability – new insights from the euro area credit register”, Macroprudential Bulletin, No 19, ECB, 2022. 
129   We examine RRE and CRE markets separately as they have different characteristics, participants and 

past dynamics. For example, there is a historical tendency for CRE exposures to be substantially riskier 
than RRE exposures due to their more volatile asset market and typically riskier lending practices. 
Indeed, CRE lending typically has higher LGDs and PDs than RRE markets. Market participants also 
differ, with RRE markets typically consisting of (domestic) households and banks while CRE markets 
include firms and a range of (international) non-banks (see the article entitled “Real estate markets, 
financial stability and macroprudential policy”, Macroprudential Bulletin, No 19, ECB, 2022). CRE 
lending is also often characterised by riskier lending practices than RRE, with wider use of non-
recourse lending, bullet lending and complex lending structures. 

Financial Stability Review, November 2023 – Special features 

108 

Possible amplifiers•Risky and large banking system exposures•Credit crunch: collateral channel and risk aversion•Procyclical selling by non-banks and firmsRising defaults and large banking system lossesRising financing costsLeveraged borrowers and borrowers with variable-rate loans or short maturity in need of refinancingFalling incomeLower wages/profits could affect repayment capacityFalling real estate prices Higher loss given defaultWealth and confidence effectsRising interest rates push down real estate pricesHigher vacancy rates/ lower rents reduce property valueHigher financing costs reduce disposable income 
 
 
 
 
Sizing up the potential for losses: price and collateral channels 

Higher financing costs after a long RRE boom are putting cyclical downward 
pressure on overvalued house prices. A standard asset-pricing model can be 
used to link equilibrium real estate prices to the discounted value of the cash flow 
that a property could provide if rented out. As the discount factor enters the 
denominator of the price equation, the relationship between property prices and 
interest rates is negative.130  Following the global financial crisis, accommodative 
monetary policy and the easing of mortgage conditions by banks, together with a 
shift in households’ preference to hold real estate assets during the pandemic, seem 
to have been the most important drivers of protracted and robust increases in house 
prices (Chart B.2, panel a). These factors all contributed to increasingly stretched 
house price valuations in the euro area.131  By contrast, positive contributions from 
monetary policy and banks’ financing conditions have dissipated since the start of 
2022. Tighter financing conditions have resulted in higher debt service costs for 
borrowers and tighter credit standards on mortgages,132  making it more expensive 
and more difficult for prospective borrowers to obtain financing, which in turn has put 
downward pressure on house prices. As a reflection of this, the extent of downside 
risks to RRE prices as measured by the ECB’s RRE price-at-risk model has 
increased abruptly, although it remains at much less severe levels than those seen 
during the global financial crisis (Chart B.2, panel b). 

Unlike cyclical developments, structural and supply-related factors continue to 
support prices in housing markets. In recent years, housing completions in the 
euro area have remained below their average level since the start of monetary 
union,133  indicating a possible accumulated structural gap between housing demand 
and housing supply.134  In addition, rising construction costs due to supply shortages 
and high input costs are exerting upward pressure on house prices.135  These factors 
are currently mitigating downside risks to house prices. Over the medium term, 
however, exposure to both physical and transition climate risk could lead to lower 

130   Indeed, there is a vast empirical literature confirming that higher interest rates tend to put downward 
pressure on house prices, all else being equal (see Dieckelmann, D., Hempell, H.S., Jarmulska, B., 
Lang, J.H. and Rusnák, M., “House prices and ultra-low interest rates: exploring the non-linear nexus”, 
Working Paper Series, No 2789, ECB, 2023). 

131   See the section entitled “Vulnerable real estate markets are turning”, Financial Stability Review, ECB, 
May 2023. Euro area house price overvaluation estimate stood at 18% in Q2 2022 and at 9% in Q2 
2023. 

132   See the Euro area bank lending survey Q3 2023, ECB, 2023. 
133   For discussions on the supply of housing in the euro area, see the article entitled “The state of the 

housing market in the euro area”, Economic Bulletin, Issue 7, ECB, 2018, and Frayne, C., Szczypińska, 
A., Vašíček, B. and Zeugner, S., “Housing Market Developments in the Euro Area: Focus on Housing 
Affordability”, European Economy Discussion Paper 171, European Commission, 2022. 

134   Demand for housing is determined by many factors, notably including the affordability of housing and 

the number of households. The total number of households in the European Union rose by 10.3% from 
2009 to 2022, increasing demand in the long term. See also Eurostat’s Household composition 
statistics, accessed on 28 September 2023. 

135   Construction producer prices for new residential buildings increased by 12% in the EU in 2022. See 
also Eurostat’s Construction producer price and construction cost indices overview, accessed on 28 
September 2023. 

Financial Stability Review, November 2023 – Special features 

109 

 
 
 
valuations for properties in certain locations and housing units with lower energy 
efficiency.136 

Chart B.2 
Cyclical factors are putting downward pressure on house prices, while structural and 
supply-related factors are continuing to support prices, at least in the near term 

a) Decomposition of real RRE price growth 

b) Tail risk to euro area house price growth 

(Q1 2014-Q4 2022; contributions as a share of identified shocks, 
percentages) 

(Q1 2000-Q3 2023; 5th percentile of predicted real year-on-year 
house price growth rate distribution, percentages) 

Sources: ECB and ECB calculations. 
Notes: Panel a: results from a vector autoregression model including real RRE prices, real lending for house purchases, the nominal 
lending rate on new loans for house purchases, the nominal shadow rate, real residential investments, and real disposable income. 
We use quarterly series for the euro area aggregate covering the period from Q1 2000 to Q4 2022. The fundamental drivers (structural 
shocks) are identified using a combination of zero and sign restrictions, with restrictions being based on relevant empirical literature.* 
“Post sovereign debt crisis” refers to Q1 2014-Q4 2019; “Early pandemic” refers to Q1-Q4 2020; “Late pandemic” refers to Q1 2021-
Q1 2022; “Recent” refers to Q1 2022-Q1 2023. Panel b: results from an RRE price-at-risk model based on a panel quantile regression 
on a sample of 19 euro area countries. The RRE price-at-risk is defined as the 5th percentile of the predicted RRE price growth; this 
provides an indication of how severe an RRE price decline could be in extreme cases. Explanatory variables: lag of real house price 
growth, overvaluation (average of deviation of house price/income ratio from long-term average and econometric model), systemic risk 
indicator, consumer confidence indicator, financial market conditions indicator capturing stock price growth and volatility, government 
bond spread, slope of yield curve, euro area non-financial corporate bond spread, and an interaction between overvaluation and a 
financial conditions index. 
*) Jarociński, M. and Smets, F., “House Prices and the Stance of Monetary Policy”, Review, Federal Reserve Bank of St. Louis, 2008; 
Calza, A., Monacelli, T. and Stracca, L., “Housing Finance and Monetary Policy”, Journal of the European Economic Association, Vol. 
11, 2013; and Nocera, A. and Roma, M., “House prices and monetary policy in the euro area: evidence from structural VARs”, Working 
Paper Series, No 2073, ECB, 2017. 

The post-pandemic recovery in CRE markets reversed sharply as interest rates 
started to increase (Chart B.1, panel b). Credit registry data for the euro area 
indicate that average rates on new loans for the purchase of CRE assets have 
increased by 2.6 percentage points since interest rates started moving upward.137 
Rising interest rates and overall uncertainty, combined with the inherent illiquidity of 
CRE markets, resulted in a sharp 47% drop in the number of transactions conducted 

136   For the impact of physical risk on house prices, see, for example, Gourevitch, J.D., Kousky, C., Liao, Y., 

Nolte, C., Pollack, A.B., Porter, J.R. and Weill, J.A, “Unpriced climate risk and the potential 
consequences of overvaluation in US housing markets”, Nature Climate Change, Vol. 13, pp. 250-257, 
2023, and Benetton, M., Emiliozzi, S., Guglielminetti, E., Loberto M. and Mistretta, A., “Do house prices 
reflect climate change adaptation? Evidence from the city on the water”, Occasional Papers, No 735, 
Banca d’Italia, 2022; for the impact of transition risk on house prices, see Ferentinos, K., Gibberd, A. 
and Guin, B., “Climate policy and transition risk in the housing market”, Staff Working Papers, No 918, 
Bank of England, 2021. 

137   A comparison of average interest rates on real estate purchase-purposed loans to non-financial 

corporations from June 2022 to June 2023, weighted by exposure size. These dynamics are largely in 
line with wider data on new lending to non-financial corporations, which suggests they do not yet 
include a rising CRE-specific risk-aversion component. 

Financial Stability Review, November 2023 – Special features 

110 

-50-40-30-20-10010203040MortgageSupplyshocksHousingSupplyshocksHousingPreferenceshocksMonetaryPolicyshocksIncomeshocksPost sovereign debt crisisEarly pandemicLate pandemicRecent-40-35-30-25-20-15-10-50510200020022004200620082010201220142016201820202022Euroarea aggregateCountry 25-75th percentile range Country 10-90th percentile range  
 
 
 
 
in euro area CRE markets over the first half of 2023 compared with the first half of 
2022. This has inhibited price discovery, which is hampering the assessment of 
actual market dynamics. The performance of real estate firms in equity markets, 
which are more liquid, suggests substantial price declines, with the euro area’s 
largest listed landlords trading at a discount of over 30% to net asset value (NAV), 
their largest discount since 2008 (Chart B.3, panel a).138 

Chart B.3 
The adverse effects of rising interest rates on CRE valuations are compounded by 
illiquidity and structural changes resulting in lower demand for certain types of assets 

a) Median price-to-NAV of large euro area 
landlords 

b) Rent growth expectations in prime and 
non-prime office and retail markets 

(2004-22, market value as a percentage of book value) 

(Q1 2014-Q2 2023; 12-month rent growth expectations, 
percentages) 

Sources: Panel a: LSEG and ECB calculations. Panel b: RICS and ECB calculations. 
Notes: Panel a: calculations are based on a sample of listed euro area CRE companies. The number of firms in the sample increases 
over time, with 100-150 firms in 2004 rising to 260 firms in 2023. Panel b: based on survey data. 

Structural challenges and climate change concerns are aggravating downside 
risks in certain segments of the CRE market. Cash flow prospects, as illustrated 
by expected rental growth, in both the office and retail sectors remain substantially 
below pre-pandemic levels (Chart B.3, panel b). This likely reflects the fact that 
behavioural changes following the pandemic (i.e. hybrid working and increased use 
of e-commerce) have permanently reduced demand in these segments. Moreover, 
the difference between prime and non-prime assets in terms of rental growth 
expectations has also widened in recent quarters, with the outlook for the non-prime 
market being particularly negative (Chart B.3, panel b). For the office segment, this 
partly reflects demand for higher-quality space as firms downsize their total office 
usage. However, climate change concerns have also been a major driver of this 
shift. Market participants are indicating that demand is increasingly concentrated in 
the market for high-quality buildings with good energy ratings. In addition, lower-

138   Limited ability to raise rents has also reduced the capacity of CRE to act as an inflation hedge in the 

way it might have done in previous inflationary periods, particularly at the levels of inflation experienced 
since early 2022. Indeed, this dynamic has been reflected in real estate firms’ equity valuations, which 
initially responded well to rising inflation and interest rate expectations but – once the extent of 
inflationary pressures and the potential interest rate response had become clearer – significantly 
underperformed wider equity markets. 

Financial Stability Review, November 2023 – Special features 

111 

50607080901001101201301401502004200520062007200820092010201120122013201420152016201720182019202020212022Median price to NAV-14-12-10-8-6-4-202468201420152016201720182019202020212022Prime office rent expecationsNon-prime office rent expectations Prime retail rent expectationsNon-prime retail rent expectations 
 
 
 
 
quality buildings face rising retrofitting costs, which exacerbate downward pressure 
on prices. Thus, while the price outlook for the market as a whole is negative, 
outcomes may be particularly severe in non-prime markets. 

Debt servicing capacity and scope for borrower distress 

Debt servicing capacity – a central factor driving PDs – is determined by a 
borrower’s leverage, income prospects and exposure to higher interest rates. 
Borrowers with variable-rate loans are typically most exposed to rising interest rates 
as their loans reprice in line with market rates. Among fixed-rate borrowers, short 
maturity lending that needs to be rolled over and loans with short interest rate 
fixation periods also create exposure to higher rates. Risks are amplified when 
borrowers are highly leveraged, which can be measured by metrics such as the loan-
to-income (LTI) ratio. Crucially, financial stability may be at risk if and where 
borrowers’ incomes are not sufficient to meet these higher financing costs, pushing 
up loan PDs at a time when LGDs are also rising. 

Firms and households in some euro area countries are particularly exposed to 
rising interest rates, given their extensive use of variable-rate lending. While 
the interest rates on new loans have direct implications for real estate prices, it is the 
cost of servicing the existing stock of loans that affects debt servicing capacity. The 
use of fixed- and variable-rate lending differs significantly across euro area countries. 
Fixed-rate lending makes up the bulk of outstanding bank loans in Germany, France 
and the Netherlands while variable-rate lending dominates in Finland and the Baltic 
states (Chart B.4, panels a and b). This, combined with a varying degree of reliance 
on short-term loans which need to be rolled over, creates substantial cross-country 
differences in exposure to rising interest rates. According to credit registry data, the 
average financing costs on the stock of loans borrowed by real estate firms in 
Germany and the Netherlands have increased by about 0.75 percentage points 
since 2019 and in Finland by as much as 2.75 percentage points (Chart B.4, panel 
a).139  This implies that in some euro area countries borrowers tend to bear the 
burden of rising interest rates, while for lenders interest income increases with 
financing costs when interest rates rise. Of course, from a wider financial stability 
perspective, the widespread use of fixed-rate lending may entail interest rate risk for 
the banks, when the interest margin turns negative due to rising interest rates on 
liabilities. 

139   While variable-rate lending dominates structurally in some countries, there has been an overall trend 
towards fixed-rate mortgage lending over the last two decades. This trend has seen the share of new 
loans with variable rates in the euro area falling from around 50% to around 15% between 2003-05 and 
2020-22, leading to a shift of some of the risk of rising interest rates from households to banks. The 
shares of variable-rate lending increased again since the end of 2022, reaching 20% in September 
2023. This might reflect the preference of borrowers not to lock in higher interest rates for a longer 
period and their expectation that interest rates will, on average, be lower over the entire life of the loan. 
However, the volume of credit for house purchase has fallen substantially since the interest rate hikes 
started (see the section entitled “Vulnerable real estate markets are turning”, Financial Stability Review, 
May 2023), so new lending amounts to a limited share of the stock of mortgage loans on banks’ 
balance sheets. 

Financial Stability Review, November 2023 – Special features 

112 

 
 
 
Chart B.4 
Highly leveraged borrowers with variable-rate lending are most exposed to rising 
interest rates 

a) Real estate firms’ exposure 
to rising interest rates and 
increases in financing costs 
since 2019 

(left-hand scale: June 2023, percentages of 
total bank loans to real estate firms by 
exposure to rising rates;   
right-hand scale: 2019-23, percentage 
points) 

b) Households’ exposure to 
rising interest rates 

c) Leverage among real estate 
firms and households 

(July 2023; percentages of total bank 
mortgage loans per interest rate fixation 
period at origination) 

(left-hand scale: multiples; 2005-21 debt: 
EBITDA < €100m assets, 2004-22 debt: 
EBITDA > €100m assets;   
right-hand scale: percentages, household 
debt-to-income) 

Sources: Panel a: ECB (AnaCredit) and ECB calculations. Panel b: ECB and ECB calculations. Panel c: LSEG (firms > €100m 
assets), BvD Electronic Publishing GmbH – a Moody’s Analytics company (firms < €100m assets), Eurostat and ECB (QSA, 
household debt-to-income) and ECB calculations. 
Notes: Panel a: a loan is defined as exposed to rollover risk if it matures within the next two years. Panel b: approximation of 
information for mortgage stocks using interest rate fixation periods at origination of cumulative mortgage flows since data availability 
starts or for the period equalling the average mortgage loan maturity when this period is shorter than data availability. Some national 
authorities have country-specific data on fixation periods of the mortgage stocks, but differences between the national data and the 
approximation based on flows are not substantial in most cases. Some differences can be seen, however, for Ireland (see Figure 1 in 
Byrne et al.*), Italy, Slovenia or Luxembourg, for example. Greece excluded due to data quality issues. 
*) Byrne, D., McCann, F. and Gaffney, E., “The interest rate exposure of mortgaged Irish households”, Financial Stability Notes, Vol. 
2023, No 2, Central Bank of Ireland, 2023. 

The impact of higher interest rates is amplified by leverage, which among 
households and larger real estate firms is close to or above pre-GFC levels. 
The ratio of household debt to income increased between 2020 and 2022 – the late 
phase of the housing market boom (Chart B.4, panel c).140  A similar pattern is 
visible for the debt/earnings ratio of large real estate firms. This metric may 
deteriorate further as these firms’ earnings decline and CRE prices are revalued 
downwards. Indeed, the first signs of such a dynamic are already visible for the 
largest firms’ debt/earnings ratios at the end of the review period. This could pose a 
challenge for highly leveraged firms that need to roll over existing debt and that face 
notably higher financing costs or even reduced access to credit. Indeed, between 
February 2022 and March 2023, Moody’s carried out negative ratings actions on 
40% of European real estate firms and cited deteriorating debt/asset ratios – an 

140   For a discussion on lending standards for new lending, where loan-to-income ratios have been also 

increasing until 2022, see the article entitled “Evolution of mortgage lending standards at the turn of the 
housing market cycle”, Macroprudential Bulletin, No 22, ECB, 2023. 

Financial Stability Review, November 2023 – Special features 

113 

0.00.51.01.52.02.53.03.54.00102030405060708090100FIEEMTLTLVCYSIGRIEPTSKATITLUESBEFRDENLEARollover riskRollover risk and variable-rate lendingVariable-rate lendingChange in financing costs (right-hand scale)0102030405060708090100FIEELTLVPTCYESMTIESILUATITHRNLDEBEFRSKEAFloating Between 1 and 5 yearsBetween 5 and 10 years Over 10 years75808590951001050246810122004200620082010201220142016201820202022Debt: EBITDA < €100m assetsDebt: EBITDA > €100m assetsHousehold debt-to-income (right-hand scale) 
 
 
 
 
 
alternative leverage measure – in 70% of these.141,142  Where this dynamic requires 
firms to collectively deleverage, it could create a negative feedback loop between 
access to financing and CRE prices. 

For households, while rising debt service costs may challenge debt servicing 
capacity, strong labour markets are mitigating default risk on mortgages. A 
microsimulation analysis assessing debt servicing capacity indicates that rising 
interest rates have pushed loan service-to-income (LSTI) ratios on variable-rate 
loans up by 8.0 percentage points on average since 2021. Half of existing highly 
leveraged borrowers with long maturity loans at origination could see their LSTI 
ratios increase by more than 15.0 percentage points, while for 10% of them the 
increase could exceed 25.7 percentage points (Chart B.5, panel a).143  In addition to 
debt service costs, the income of a given borrower is an important determinant of 
default risk (Chart B.5, panel b), implying that a scenario featuring a substantial 
weakening of the labour market would be a source of concern from a financial 
stability perspective.144,145 

By contrast, real estate firms are vulnerable to losses in the current 
environment, with consequences for the resilience of banks’ loan books. Loans 
to landlords account for around two-thirds of banks’ exposures to real estate firms, 
while structurally lower demand for CRE assets reduces landlords’ capacity to raise 
rents. Developers and landlords alike face rising costs from inflationary pressures 
and capital expenditures associated with higher energy efficiency requirements. 
Developers are under further pressure from falling sales prices and contracting order 
books. This implies that profits for real estate firms may in fact fall in the coming 
years rather than keep pace with rapidly rising financing costs, posing challenges to 
debt servicing capacity. Indeed, a deterioration in firms’ fixed charge ratios was the 
most commonly cited factor in Moody’s recent rating downgrades.146  As for bank 
loans to real estate firms, the recent rise in financing costs may cause the share of 
loans extended to loss-making firms to double to as much as 26%. If tighter financing 
conditions persisted for two years and firms were required to roll over all maturing 
loans, this number would increase to 30%. Finally, 53% of loans in the sample would 

141   Rating actions included both changes in outlook and changes in ratings. See “Corporate credit quality 

will deteriorate with rising rates, falling property values”, Moody’s, 7 February 2023. 

142   For a discussion of collateral and earning constraints in corporate borrowing, see Horan, A., Jarmulska, 
B. and Ryan, E., “Asset prices, collateral and bank lending: the case of Covid-19 and real estate”, 
Working Paper Series, No 2823, ECB, 2023, and Lian, C. and Ma, Y., “Anatomy of Corporate 
Borrowing Constraints”, The Quarterly Journal of Economics, Vol. 136, Issue 1, February 2021, pp. 
229-291. 

143   Based on data on securitised mortgage loans for countries where variable-rate lending prevails 
(Ireland, Spain, Italy and Portugal, available from European DataWarehouse (EDW)). In the 
microsimulation, highly leveraged borrowers are those with an LTI exceeding seven while “long 
maturity” means longer than 30 years. Overall, around 30% of loans in the euro area are granted at 
variable rates (Chart B.4, panel b). 

144   The euro area unemployment rate stood at a historical low of 6.4% in August 2023 and is projected to 
increase to 6.7% in 2024. For more details, see the ECB staff macroeconomic projections for the euro 
area, September 2023. 

145   Household default risk may also be mitigated in some countries by support measures for household 
borrowers that are already in place or being designed. Whether or not a borrower defaults will also 
depend on accumulated savings. Even in the absence of defaults, however, higher debt service ratios 
caused by higher interest rates could have significant negative macroeconomic implications due to 
decreased consumption. 

146   See “Real estate – Europe: Corporate credit quality will deteriorate with rising rates, falling property 

values”, Moody’s, 7 February 2023. 

Financial Stability Review, November 2023 – Special features 

114 

 
 
 
be to loss-making firms if firms simultaneously experienced a 20% drop in turnover. 
In some cases, losses are substantial – for 17% of loans, annual losses exceed 10% 
of the firm’s total capital (Chart B.5, panel c).147  These results suggest there are 
substantial vulnerabilities in this loan book, particularly when considering that it is 
expected that both higher financing costs and reduced profitability will persist for a 
number of years. Indeed, business models established on the basis of pre-pandemic 
profitability and low-for-long interest rates may become unviable over the medium 
term. 

Chart B.5 
Higher debt service costs may have credit risk implications for variable-rate loans 
and for real estate firms with weak profitability 

a) Simulated increases in LSTI 
ratios on variable-rate loans 
since end-2021 

b) Marginal effects of factors 
relevant for household 
probabilities of default 

c) Share of total real estate 
firm loans to loss-making 
firms under three scenarios 

(2012-23, percentage points) 

(effects on probability of default) 

(June 2023, percentages) 

Sources: Panels a and b: EDW and ECB calculations. Panel c: BvD Electronic Publishing GmbH – a Moody’s Analytics company, ECB 
(AnaCredit) and ECB calculations. 
Notes: Panels a and b: only variable-rate loans are shown in countries available in EDW (Ireland, Spain, Italy and Portugal). Panel a: 
loans originated in 2012-21; loans expiring before 2023 dropped. The chart shows simulated increases in LSTI ratios between 2021 
and 2023. LSTI ratios in 2023 are calculated on the basis of the household cost of borrowing (MIR) in August 2023 plus 25 basis 
points interest rate hike in September. Boxes based on 10th, 50th and 90th percentiles, whiskers on 1st and 99th percentiles. The total 
is weighted by GDP. Further details on the methodology underlying this analysis can be found in the article entitled “Gauging the 
sensitivity of loan-service-to-income (LSTI) ratios to increases in interest rates”, Macroprudential Bulletin, Issue 19, ECB, October 
2022. Panel b: the chart shows average marginal effects of relevant right-hand-side variables included in the logistic regression of one-
year-ahead probabilities of default of mortgage loans. Further details can be found in the article entitled “The analytical toolkit for the 
assessment of residential real estate vulnerabilities”, Macroprudential Bulletin, Issue 19, ECB, October 2022. Panel c: based on a 
sample of 115,000 firms for which profitability data are available in the BvD dataset, accounting for approximately 25% of loans in 
AnaCredit to real estate firms. Firms’ losses categorised by size relative to firm capital. Sample coverage across countries varies, with 
countries where variable-rate lending is prevalent generally having higher coverage than those which typically use fixed-rate lending. 
Firm profitability, including the estimated impact of changes in financing costs, is calculated as 2019 net income (excluding the effects 
of depreciation/amortisation) – (change in borrower average cost of financing) *total debt. This is normalised by firm capital, which 
includes all equity and reserves. Under a full pass-through scenario, (1) the further 50 basis points of monetary tightening which has 
occurred since June 2023 is incorporated in all variable-rate loans; (2) all loans expiring within two years are rolled over at the new 
rates; and (3) all fixed-rate loans with rate resets scheduled in the next two years are updated to the new rates, where new rates are 
calculated as original interest rate + change in long-term government bond yields since original loan inception. A 20% decline in 
turnover is uniformly applied to all firms to account for the various profitability headwinds facing the real estate sector discussed in the 
main text. AnaCredit data are as at June 2023. 

147   This analysis is based on a sample of 115,000 euro area real estate firms. For further details on the 

analysis, see the notes to Chart B.5. 

Financial Stability Review, November 2023 – Special features 

115 

0510152025303540LTI<=7LTI>7Maturity 0-25 yearsMaturity 26-30 yearsMaturity over 30 years-0.0020.0000.0020.0040.0060.0080.010Current LTVUnemploymentrateLSTI atoriginationReal incomegrowthInterest rate0102030405060June 23financingcostsFull pass-through ofcurrentratesFull pass-through –20% turnoverLoss-making, 2019Firm losing 0-5% capital Firm losing 5-10% capitalFirm losing 10-20% capital Firm losing >20% capital  
 
 
 
 
 
Conclusions 

While mitigating factors are supporting banks’ large mortgage portfolios for 
now, banks’ smaller CRE exposures appear to be more vulnerable. Despite 
falling real estate prices and rising financing costs in both RRE and CRE markets, 
robust labour markets are currently helping to mitigate credit risk in mortgage 
portfolios. However, any substantial weakening of the labour market would pose 
significant risks to the RRE portfolios. By contrast, the weak profitability outlook is 
creating greater downside risks in banks’ CRE portfolios. Aggregate CRE exposures 
are substantially smaller than for RRE and are unlikely by themselves to be large 
enough to cause a systemic crisis at the euro area level. Nevertheless, a scenario 
where real estate firms suffer very large losses would likely coincide with stress in 
other sectors. In this way, CRE market outcomes have the potential to significantly 
amplify an adverse scenario, increasing the likelihood of systemically relevant losses 
being incurred in the banking system. Moreover, a negative outcome of this type 
would also drive large losses in other parts of the financial system which are 
significantly exposed to CRE, such as investment funds and insurers. 

Macroprudential policy measures might also help to reinforce resilience, 
especially for RRE. Almost all euro area countries have implemented 
macroprudential measures to address RRE vulnerabilities, but policy action targeting 
CRE has been much more contained. Many countries increased macroprudential 
capital buffers or implemented borrower-based measures in response to increasing 
RRE vulnerabilities after the pandemic subsided. By mid-2023, 15 of the 20 euro 
area countries had put borrower-based measures in place, ten had implemented 
targeted capital-based measures (sectoral systemic risk buffers or measures to 
increase risk weights), and several had increased broad countercyclical capital 
buffers (among others) in response to the high level of accumulated RRE 
vulnerabilities.148  By contrast, very few measures in euro area countries target CRE 
vulnerabilities, as the complexity of CRE markets and the high number of diverse 
players make a policy response more difficult to design.149  While the range of tools 
applicable at the level of banks is, in principle, identical to that of the RRE toolkit, 
measures available to investment funds or insurance corporations are scarce. In 
addition, data gaps are more substantial than they are for RRE and hinder risk 
assessment. All in all, a comprehensive policy response for CRE markets would 
require multiple measures to be implemented to target all exposed actors and avoid 
leakages and would need to take particular care to avoid procyclicality. Regardless 
of whether targeted RRE or CRE measures are in place in each country, however, 
the internal processes of banks and non-banks should ensure that their provisioning 
practices and capital properly reflect the level of accumulated vulnerabilities. 

148   See “Vulnerabilities in the residential real estate sectors of the EEA countries”, ESRB, 2022, the 

ESRB’s overview of national macroprudential measures and the list of macroprudential measures in 
euro area countries notified to the ECB. 

149   See “Vulnerabilities in the EEA commercial real estate sector”, ESRB, 2023. 

Financial Stability Review, November 2023 – Special features 

116 

 
 
 
 
Acknowledgements 

The Financial Stability Review assesses the sources of risks to and vulnerabilities in the euro area financial system based on regular 
surveillance activities, analysis and findings from discussions with market participants and academic researchers. 

The preparation of the Review was coordinated by the ECB’s Directorate General Macroprudential Policy and Financial Stability. The 
Review has benefited from input, comments and suggestions from other business areas across the ECB. Comments from members of 
the ESCB Financial Stability Committee are gratefully acknowledged. 

The Review was endorsed by the ECB’s Governing Council on 15 November 2023. 

Its contents were prepared by Desislava Andreeva, Pierce Daly, Daniel Dieckelmann, John Fell, Sándor Gardó, Paul Hiebert, Annalaura 
Ianiro, Benjamin Klaus, Thore Kockerols, Mara Pirovano, Andrzej Sowiński, Manuela Storz, Christian Weistroffer and Jonas 
Wendelborn. 

With additional contributions from Jakob Adolfsen, Marcus Bierich, Lorenzo Cappiello, Soma Gecse, Maciej Grodzicki, Lieven Hermans, 
Nathan Huber, Paulina Jacobsen, Barbara Jarmulska, Sujit Kapadia, Kateryna Koroliuk, Georgi Krustev, Peter McQuade, Caterina 
Negri, Charles O’Donnell, Cristian Perales, Moreno Roma, Ellen Ryan, Beatrice Scheubel, Michal Slavik, Seng-Guan Toh, Elisa Telesca, 
Michael Wedow, Stefan Wredenborg and Balázs Zsámboki. 

Editorial, multimedia and production assistance was provided by Maria Canelli, Marina Decker, Paula González Escribano, Anna 
Heckler, Peter Nicholson and Verena Reith. 

© European Central Bank, 2023 

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For specific terminology please refer to the ECB glossary (available in English only). 

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ISSN 1830-2025, QB-XU-23-002-EN-N 
ISSN 1830-2025, QB-XU-23-002-EN-Q