Eurozone: Financial system still fragile


In view of inflation and banking turbulence, the ECB warns of increased risks for the stability of the financial system in the euro area. The prospects for financial stability in the currency union remained unstable.

Blue euro logo with the stars of the Union in front of the old ECB headquarters in Frankfurt

“Price stability is crucial for lasting financial stability,” said the Vice President of the European Central Bank (ECB), Luis de Guindos, on Wednesday in Frankfurt. Presenting the central bank's twice-yearly Financial Stability Report, he said: “As we tighten monetary policy to bring down high inflation, this may reveal vulnerabilities in the financial sector.”

In its fight against high inflation, the ECB has raised interest rates seven times in a row since July 2022. The deposit rate, which is decisive on the financial market and which financial institutions receive from the central bank for parking excess funds, is currently 3.25 percent – a year ago it was still negative at minus 0.5 percent.

The ECB has probably not yet reached the end of its increase path. At 7.0 percent in April, inflation is still more than three times the central bank's target of two percent. Most recently, several euro watchdogs considered further interest rate hikes in June and July to be likely.

Fear of recession

Financial stability in the euro area remains highly vulnerable, the report said. The financial markets are prone to price corrections if growth and inflation develop unfavourably. Stretched valuations, tighter financing conditions and lower market liquidity increased the risk that price corrections could get out of hand. This applies in particular if new recession fears should arise. Investment funds could also amplify unfavorable market dynamics with forced purchases of securities should they suddenly run into liquidity problems.

The tighter financing conditions also tested the resilience of households, companies and governments. For companies that emerged from the Corona crisis with higher debts and fewer profits, this could be particularly problematic due to uncertain business prospects.

At the same time, the high inflation is putting a strain on households, as their purchasing power is decreasing and possibly also yours ability to repay debt. “Sustaining inflationary pressures could require even more pronounced monetary policy responses from major central banks than market participants are currently expecting,” the ECB warned.

Sheet lightning in the banking system: UBS (left) takes over the knocked out Credit Suisse (right)

Turbulence is a warning sign

The euro central bank also pointed out that the markets for commercial real estate and residential real estate began to show corrections after years of expansion. “In the face of all these challenges, the resilience of euro area banks is remarkable, but should not lead to complacency,” de Guindos wrote in the report's foreword.

The recent banking turmoil in the US and Switzerland has showed how much the preservation of financial stability depends on the financial economy being able to absorb shocks. In the USA, three regional banks had collapsed since the beginning of March after enormous withdrawals of funds due to liquidity concerns. In Europe, the major bank Credit Suisse, which had previously had problems, was saved from going under thanks to a state-organized emergency takeover by the larger UBS.

dk/(hb (dpa, rtr)