Financial Stability Review June 25 Presentation by Tommaso Padoa-Schioppa 31 May 25 1
Outline I Financial Stability concepts and processes II Areas of vulnerability Global macro-finance Financial markets Euro area economic balances Financial institutions III Outlook for risks IV Overall assessment 2
Financial stability mandate of the ESCB Treaty base - Article 15(5) Since 1999: Banking Supervision Committee prepares internal banking stability reports February 23: First BSC report on banking stability published December 24: First ECB Financial Stability Review published Governing Council has regular semi-annual discussions of financial stability issues on the basis of a financial stability review Financial Stability Review to be published twice a year in June and December from now on 3
June 25 Financial Stability Review Scope Structure Analytical highlights Co-operative production process 4
Main areas of vulnerability Global macro-finance Financial markets Euro area economic balances Financial institutions 5
Global macro-finance US imbalances widen and oil prices reach new highs Net lending/borrowing of the US economy (% of GDP) Evolution of Chinese crude oil imports and oil prices 2 Chinese net crude oil imports (USD billions, left-hand scale) WTI oil price (USD per barrel, right-hand scale) 1 4 6-1 -2-3 -4-5 3 2 1 5 4 3 2 1-6 195 196 197 198 199 2-1 1993 1995 1997 1999 21 23 25 6
Financial markets Corporate bond spreads widening, equity market volatility rising Spread of corporate bonds issued by US industrial companies VIX implied volatility in the US stock market 135 13 125 12 115 11 15 1 95 9 Jan-4 Apr-4 Jul-4 Oct-4 Jan-5 Apr-5 45 4 35 3 25 2 15 1 5 22 23 24 25 7
Euro area sectoral balances corporate sector Large firms improving but small firms remain weak Costs, sales and profits of Dow Jones EURO STOXX 5 companies (EUR billions) Expected default frequency distributions for large and small euro area firms 33 32 31 sales (left-hand scale) costs (left-hand scale) net income (right-hand scale) 25 2 3.5 3. 2.5 small, Mar. 24 small, Mar. 25 large, Mar. 24 large, Mar. 25 3 29 15 1 probability (%) 2. 1.5 28 1. 27 5.5 26 22 23 24...5 1. 1.5 2. expected default frequency 8
Euro area sectoral balances households Balance sheets and risks expand further House price-to-rent ratios in the euro area (index: 1999 = 1) Household debt-to-financial and liquid financial assets (%) 18 17 16 15 euro area Germany France Italy Spain Netherlands 9 85 household debt-to-financial assets (right-hand scale) household debt-to-liquid financial assets (left-hand scale) 3 29 14 8 28 13 12 75 27 11 7 26 1 9 65 25 8 1999 2 21 22 23 24 6 1995 1996 1997 1998 1999 2 21 22 23 24 9
Financial institutions banks Broad recovery of profitability and lower provisioning Return on equity (ROE) of large euro area Institutions (%) Loan loss provisions of large euro area institutions (% of total assets) 5 4 3 max-min range inter-quartile range average 5 4 3 1.2 1. max-min range inter-quartile range average 1.2 1. 2 2.8.8 1 1.6.6-1 -1-2 -2.4.4-3 -3.2.2-4 -4-5 2 21 22 23 24-5. 2 21 22 23 24. 1
Financial institutions insurance Indications of improving financial health Cumulative change in euro area insurance stock price indices relative to the Dow Jones EURO STOXX 1 5 non-life insurers life insurers reinsurance Risk neutral probability density function on the DJ EURO STOXX insurance index.7.6 15-Oct-4 6-May-5.5-5.4-1.3-15 -2-25 Jan-4 Apr-4 Jul-4 Oct-4 Jan-5 Apr-5.2.1. 1 12 14 16 18 2 22 value of the insurance stock index 11
Financial institutions hedge funds Risks for markets of crowded trades Medians of pairwise correlation coefficient of monthly hedge fund returns within strategies.8.7.6 convertible arbitrage (6%) fixed income arbitrage (7%) equity market neutral (5%).8.7.6 Fund of Funds event driven (19%) managed futures (5%).5.5.4.4.3.3.2.2.1.1.. -.1 94 95 96 97 98 99 1 2 3 4 -.1 94 95 96 97 98 99 1 2 3 4 12
Outlook for risks: main sources of uncertainty Financial fragility may increase if: Markets abruptly re-assess risks, especially credit risks Global re-balancing becomes disorderly Oil prices remain persistently high Low levels of provisioning prove to be inadequate 13
Overall assessment: likely outcomes are bi-modal The outlook for financial stability is more mixed than six months ago: The pace of global economic activity has remained quite strong Balance sheets of large corporations have improved further Balance sheets of financial institutions have been strengthened But risks have not declined: Possibility of disorderly correction of serial bubbles Possible unruly unwinding of global imbalances High oil prices and sluggish domestic demand raise corporate sector credit risks Further increases raise risks of house price correction 14