FRANKFURT: The European Central Bank said Wednesday that stress in the eurozone financial system had remained low over the past six months, but it warned of “significant” risks to that stability.
“Risks to financial stability stemming from financial markets remain significant, mainly owing to the possibility of a further rapid repricing,” the Frankfurt-based institution wrote in its half-yearly Financial Stability Review.
Demand has been high in recent years for sovereign debt issued by governments seen as stable, such as Germany.
Such bonds are regarded as safe havens for investors to park their cash in the current climate of political uncertainty.
That has kept prices high and the yield, or investors’ return on the bond, low.
However, the prospect of higher returns in the United States, as monetary and fiscal policy changes with faster growth and the new administration under Donald Trump, could see investors pull money out of European bonds and move it across the Atlantic.
If a lot of money is shifted in a short time, the price of European bonds could fall sharply, leaving eurozone banks, insurance firms, pension funds and other institutions facing “substantial capital losses,” the ECB warned.
The same movement would mean that eurozone “bond yields could increase abruptly without a simultaneous improvement in growth prospects,” it continued.
That would mean that “insufficient structural reform and fiscal adjustment efforts… may put pressure on the sustainability of public finances in some countries,” the ECB said.
It urged countries to do their economic homework and improve their resilience to financial shocks.
Other risks highlighted by the ECB included the continuing low profitability at eurozone banks, sapped by low interest rates and high levels of non-performing loans in some countries.
It also pointed to intense price pressure and inefficiencies due to the high number of competing institutions.
Looking to Britain’s departure from the European Union, the ECB suggested that while that added to “the prevailing level of political uncertainty… the ‘Brexit’ process itself is currently not one of the main concerns for euro area financial stability.”
Even in the long term, “the risk that the euro area real economy would face restrictions in accessing wholesale and retail financial services following the UK’s departure… appears limited,” the central bank found.
Nevertheless, banks and financial companies still had more work to do to prepare.
“Relocation of financial services capacity during the transition… could, in some cases, face frictions,” the ECB added.
That appeared to be a reference to the battle over whether “clearing houses” dealing in euros — a vital part of the financial system’s plumbing — will continue to be based in London.