ECB report finds eurozone financial stability challenging

The euro area financial stability environment remained challenging, the European Central Bank (ECB) said in a report published Wednesday, calling for monitoring and action towards excessive financial risk-taking and more active use of macro-prudential instruments.

Against a background of subdued growth and economic downside risks in euro area, search for yield has continued in the low interest rate environment and given rise to signs of excessive leverage and risk-taking, according to the latest Financial Stability Review, published twice a year by the ECB.

Such signs of excessive risk-taking, including for some non-bank financial institutions, highly leveraged corporates and real estate sectors, require monitoring and targeted macro-prudential policy action, the ECB said.

Meanwhile, targeted macro-prudential policy measures are in place to address vulnerabilities in the banking sector and real estate markets, but the toolkit for non-banks needs to be further developed, the ECB analysts noted.

While admitting that deep and broad capital markets supported by non-bank investors bring many benefits to the real economy, the report found fragility in these markets or in non-bank financial intermediaries could be a source of systemic risk.

According to the review, although all euro area countries have activated macro-prudential measures, the ECB called for more active use of the macro-prudential policy to counter vulnerabilities.

The report also addressed the bank profitability concern. The banking sector has grown more resilient over the years, but their slow progress in improving profitability and renewed cyclical headwinds may hinder the banks' ability to respond to downside risks, it said.

In particular, it argued that for certain subsets of banks, the reduction of overcapacity, such as through consolidation, could help improve their performance.