ECB Warns Calm Before Storm Ending

The European Central Bank warned yesterday that six quarters of recession are eroding the resilience of banks and risk ending what it describes as 'the calmest period in financial markets since 2011'. As Bloomberg's Niraj Shah notes, the Bloomberg Euro-area Financial Conditions Index has averaged 0.31 this year, compared with -1.47 in 2012 and the measure has only ended in negative territory on three days this year. However, it has very recently fallen to its lowest in a month as financial CDS begin to rise (even with Mrs. Watanabe's presence) to once again wider on the year. As The ECB adds, "Financial stability conditions in the euro area remain fragile. Several vulnerabilities in the interaction between sovereigns, banks and the macroeconomy persist."


Via The ECB:

Financial stability conditions in the euro area remain fragile.


Several vulnerabilities in the interaction between sovereigns, banks and the macroeconomy persist. Further concrete action by the public and private sector is needed to durably sever negative feedback loops between distressed sovereigns, increasingly diverging economic growth prospects at the country level and concerns about the financial soundness of banks. A roadmap has been drawn up for completing Economic and Monetary Union (EMU). Its completion, including notably the part related to the banking union, is essential.


The ECB Review highlights four key risks to euro area financial stability:

  • A further decline in bank profitability, linked to credit losses and a weak macroeconomic environment. Continued and prompt progress in proactively tackling bank balance sheet problems is needed.
  • Renewed tensions in sovereign debt markets due to low growth and slow reform implementation. Progress in adjusting public finance vulnerabilities should not unravel. Beyond this, continued momentum is needed towards completing a genuine EMU, notably including a full banking union and a strengthening of fiscal frameworks.
  • Bank funding challenges in stressed countries. Continued steps at both the national and European level are needed to tackle remaining fragmentation in bank funding. Furthermore, bank funding markets will benefit from a predictable and consistent approach to bank supervision and resolution across Europe; the launch of the single supervisory mechanism will be a key milestone in this respect.
  • Reassessment of risk premia in global markets, following a prolonged period of safe-haven flows and search for yield. Stable and predictable policies are key to the prevention of such a risk reversal. To reduce the losses of such a possible risk reversal, banks and supervisors should ensure that bank capital buffers are sufficient.


Financial Conditions remain 'green' - based on market indicators - but have rolled over in recent days...


Though as is clear, European financial credit (green) is notably less impressed than European financial stocks (red) on the year...


Hardly surprising when one looks at the disconnect between equities and macro reality...


And in case you thought the ECB's SME lending plans were going to save the day - they are already talking that back: As Reuters notes, the ABS market for small and mid-sized companies "is a very small thing indeed, very small," said [ECB's] Constancio. "So let's not overblow this thing. It's an option, I won't say more."


Charts: Bloomberg