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European Central Bank highlights continued sector-wide risk in latest Financial Stability Review

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  • Real Estate Struggles:
    • Geopolitical tensions, lacklustre growth, and inflation impact European financial markets.
    • Residential and commercial real estate markets in the euro area face challenges due to rising debt service costs.
    • Residential real estate sees reduced affordability and demand due to rising mortgage prices.
    • Commercial real estate experiences a lack of interest in office and retail spaces amid the Covid-19 pandemic.
  • Impact on Economy:
    • Loan maturity extensions during low-interest periods may have delayed the full impact on economic activity.
    • Challenges in real estate are expected to affect both financial and non-financial sectors.
  • Non-Bank Financial Institutions:
    • Investment funds and non-bank financial institutions are highly sensitive to liquidity, credit, and leverage risks.
  • Challenges for Banks:
    • Banks face challenges as higher interest rates are relayed to depositors.
    • Funding costs for banks are expected to increase as the composition of funding transitions to more expensive term deposits or bonds.
  • Bank Asset Quality:
    • Rising debt service costs and a weak macroeconomic environment may lead to a drop in the quality of bank assets.
    • Anticipation of a substantial drop in lending volumes.
  • Economic Outlook and Vigilance:
    • Weak economic outlook and high inflation strain the ability to service debt.
    • Vigilance is crucial as the economy transitions to higher interest rates and faces growing uncertainties and geopolitical tensions.
  • Capital Buffer Requirements:
    • Increased capital buffer requirements imposed by macroprudential authorities.
    • Banks are advised to maintain buffers alongside existing borrower-based measures.
    • Emphasis on faithful implementation of Basel III for sector-wide risk mitigation.
  • Non-Bank Financial Sector:
    • Non-bank financial sector needs a comprehensive and decisive policy response according to the ECB’s review.

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