Fear of course corrections in the financial markets is growing among European banking supervisors.

After the EU supervision EBA warned of this risk on Friday, the supervisors of the European Central Bank (ECB) followed suit on Tuesday.

In a blog post, chief supervisor Andrea Enria and chief strategist Mario Quagliariello wrote that the extensive public aid measures in the corona crisis had prolonged the low interest rate environment and significantly increased liquidity.

That in turn made market participants negligent in dealing with risks.

Markus Frühauf

Editor in business.

  • Follow I follow

Enria and Quagliariello refer to the favorable financing conditions and low risk premiums for government and corporate bonds, which have fallen even further compared to the level before the pandemic. It is noteworthy that the two ECB supervisors rate the distorted risk premiums as a danger for the banks, even though the central bank's monetary policy has been consciously working towards lower bond yields through its bond purchases for years.

The ECB supervisors also refer to the high valuations on the stock markets. The hunt for returns has led to overstretched price valuations in certain market areas, some of which have decoupled from the economic fundamentals. This has increased the risk appetite of the banks, which is shown by the higher stocks of risky takeover financing (leveraged loans) and equity derivatives. In addition, exposure to risky counterparties and poor transparency have increased.

Similar to the Bank for International Settlements (BIS) the day before, the ECB supervisors count so-called “non-bank financial intermediaries” among the risky counterparties. In their official language, the central banks use this term to summarize all financial institutions that are part of the shadow banks. This can range from strictly regulated insurers to mutual funds and asset managers to risky hedge funds. The ECB supervisors urge banks to be more vigilant in the face of sudden corrections in the bond and equity markets. In their view, these can be triggered by sudden adjustments in inflation and interest rate expectations.

For the next three years, the ECB's banking supervisors will make sure that the banks survive the pandemic in good health.

They have not yet given the all-clear regarding possible loan defaults, even if they now rate their expectations at the beginning of the Corona crisis as "too pessimistic".

Furthermore, they look at deficiencies in digitization and corporate management.

After all, they want to focus more on new risks from climate change, information technology and cyber attacks.

Keywords: