Three European Supervisory Authorities (ESAs), the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA), have issued a joint risk assessment report for 2022 highlighting increased vulnerabilities across the financial sector as well as the rise of environmental and cyber risks.
The invasion of Ukraine by Russia and its economic ramifications have worsened the outlook for growth and inflation, and increased market volatility. Market resilience will be determined by markets’ and financial institutions’ ability to deal with the economic effects of Russia’s invasion of Ukraine, as well as their ability to resist changes in monetary and fiscal policy support without causing substantial disruptions.
The EU economy was on course to make a robust recovery from the Covid-19 pandemic-related crisis and the financial sector proved to be largely resilient. However, new waves and variants of the virus, concerns about inflation risk, rising commodity prices and increased geopolitical risks, along with the Russian invasion, have hampered the recovery.
Over time, the financial system has seen additional vulnerabilities and risks build up. Persistently low interest rates alongside accommodative monetary policies have driven “search for yield” behaviour that has made financial markets vulnerable to a deteriorating market sentiment, particularly if financial conditions should tighten unexpectedly due to inflationary pressures.
“Financial institutions and supervisors should prepare for a possible deterioration of asset quality in the financial sector,” stressed ESMA.
“Fund liquidity needs to be closely monitored should market liquidity deteriorate in case of wider market stress.”
The report also recommended that institutions incorporate ESG considerations into their business strategies, and warned against the possibility of increased cyber-attacks.