Vítor Constâncio ECB Financial Stability Review November 214 27 November 214 Press briefing presentation
Rubric Recent developments Euro area systemic stress has remained at low levels despite intermittent financial market turbulence Indicators of stress among euro area banks and sovereigns remain at low levels Measures of financial market, banking sector and sovereign stress in the euro area (Jan. 211 14 Nov. 214) composite indicator of systemic stress in sovereign bond markets (right-hand scale) 28.7 May FSR 24 2 16 probability of default of two or more LCBGs (percentage probability; left-hand scale) composite indicator of systemic stress in financial markets (right-hand scale).6..4 Systemic stress across the broader financial system also contained 12 8 4 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Sources: Bloomberg and ECB calculations. Notes: (i) Probability of default of two or more LCBGs refers to the probability of simultaneous defaults in sample of 1 large and complex banking groups (LCBGs) over a one-year horizon. (ii) For further details on the CISS methodology, see Hollo, D., Kremer, M. and Lo Duca, M., CISS a composite indicator of systemic stress in the financial system, Working Paper Series, No 1426, ECB, March 212..3.2.1. 2
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Economic growth outlook is underlying all key risks: Significant uncertainty surrounding the weak, fragile and uneven economic recovery and the current period of very low inflation Has the potential to aggravate and trigger the existing vulnerabilities if the current situation continues for longer than expected or conditions deteriorate further Annualised earnings per share (EPS) for selected large euro area financial institutions and real GDP growth in the euro area (Q1 22 21) 4 3 2 1-1 -2-3 -4 - real GDP growth (percentage change per annum) banks' EPS (EUR) insurers' EPS (EUR) -6 22 23 24 2 26 27 28 29 21 211 212 213 214 21 Sources: ECB, European Commission, Thomson Reuters Datastream and ECB calculations. Notes: ECB forecasts for real GDP growth and analyst estimates for earnings per share. Forecasts for 21 4
Risk 1 - Abrupt reversal of the global search for yield, amplified by pockets of illiquidity, with signs of a growing use of leverage in the non-bank financial sector A search for yield has continued across global financial markets albeit with some rebalancing out of high-yield corporates and emerging markets over last ½ year Selected bond yields and expected euro area equity returns (Jan. 1999 Oct. 214; percentages) 2 2 1 1 euro area expected equity returns emerging market external sovereign debt yield euro area non-financial corporate high yield bond yield euro area corporate investment grade bond yield 1999 21 23 2 27 29 211 213 Sources: Bloomberg, Bank of America/Merrill Lynch indices, R. Shiller, (Yale University), ECB and ECB calculations. Note: The euro area expected equity return is the inverted Shiller cyclically-adjusted price/earnings ratio. Cumulative changes in bond yields since May 213 (2 May 213 14 Nov. 214; cumulative change in basis points; ten-year sovereign bond yields) 2 16 12 8 4-4 -8-12 -16 emerging market sovereign bonds US sovereign bonds German sovereign bonds -2 euro area high-yield corporate bonds -24 average for Irish, Italian, Portuguese and Spanish sovereign bonds May-13 Aug-13 Nov-13 Feb-14 May-14 Aug-14 Nov-14 Sources: Bloomberg and JP Morgan Chase & Co. May FSR
Risk 1 - Abrupt reversal of the global search for yield, amplified by pockets of illiquidity, with signs of a growing use of leverage in the non-bank financial sector Increased financial market volatility in recent months highlight investor uncertainty regarding valuations Implied market volatilities (Jan. 1999 14 Nov. 214; ten-day moving average; index: average since 1999 = 1) 3 3 VIX VSTOXX global FX volatility implied bond market volatility (1-month Treasury options) 11 1 Steady increase in the euro shadow banking sector suggests that vulnerabilities are likely to have been growing more in this segment Assets of selected euro area financial sectors (Q1 29 Q3 214; index: Q1 29 = 1) 24 22 2 shadow banks: overall shadow banks: investment funds (excl. money market funds) shadow banks: hedge funds banks bank loans to households and non-financial corporations 2 9 18 2 1 8 7 16 14 12 1 6 1 1999 22 2 28 211 214 May-14 Sep-14 8 29 21 211 212 213 214 Source: Bloomberg. Sources: ECB and ECB calculations. 6
Risk 1 - Abrupt reversal of the global search for yield, amplified by pockets of illiquidity, with signs of a growing use of leverage in the non-bank financial sector Direct exposure to debt markets for institutional investors and less on banks Bond holdings of euro area MFIs, insurers and pension funds and investment funds (percentage of total assets) Share of euro area bonds held by euro area MFIs and investment funds (Q1 29 Q2 214; percentage of total bonds outstanding) 4 3 non-euro area corporate and government bonds euro area corporate bonds euro area government bonds 4 MFIs' holdings of non-financial corporate bonds MFIs' holdings of government bonds investment funds' holdings of non-financial corporate bonds investment funds' holdings of government bonds 3 3 2 3 2 2 1 2 1 1 1 28 Jun-14 28 Jun-14 28 Jun-14 MFIs excl. Eurosystem Insurers and pension funds Investment funds 29 21 211 212 213 214 Source: ECB. Source: ECB. 7
Risk 2 - Persistent weak bank profitability in a weak, fragile and uneven macroeconomic recovery Continued weak bank profitability not only for euro area banks amid cyclical headwinds Pre- and post-provision return on equity of euro area and global large and complex banking groups (H1 27 H1 214; percentages; medians) 3 3 Pre-provision return on equity Return on equity euro area LCBGs non-euro area European LCBGs and much needed de-risking of bank balance sheets with further balance sheet adjustment needed in parts of the banking system Return on equity and leverage of euro area significant banking groups (Q1 24 21; medians) 24 leverage (ratio; right-hand scale) return on equity (percentage; left-hand scale) return on equity, analyst forecast for 21 (percentage; left-hand scale) 21 2 US LCBGs 2 2 2 16 19 1 1 12 8 Banks' current cost of equity 8-12% 18 17 4 16 27 29 211 213 27 29 211 213 Sources: SNL Financial and ECB calculations. Note: Non-euro area European LCBGs include banks from the United Kingdom, Switzerland, Sweden and Denmark. Two-period moving average. 24 2 26 27 28 29 21 211 212 213 214 21 Sources: Bloomberg and EBA. Notes: The cost of equity estimate is taken from banks replies to the EBA risk assessment questionnaire for banks reported in EBA, Risk Assessment of the European Banking System, June 214. 1 8
Risk 3 - Re-emergence of sovereign debt sustainability concerns, amid low nominal growth and wavering policy determination for fiscal and structural reforms Ongoing fiscal adjustments, but challenges include weak, fragile and uneven economic prospects Unfinished progress towards weakening the links between sovereign and banks from height of crisis General government debt and deficits in the euro area (percentage of GDP) Sovereign and bank CDS spreads (July 211 14 Nov. 214; basis points) 4 4 3 Bank CDS spreads 3 2 2 1 1 euro area July 211 - May 214 euro area May - Nov. 214 global July 211 - May 214 global May - Nov. 214 1 1 2 2 3 3 4 4 Sovereign CDS spreads Source: European Commission. 9 Sources: Bloomberg and ECB calculations. Note: Average CDS spread for euro area and global LCBGs versus the average sovereign CDS spread where the LCBGs are headquartered (France, Germany, Italy, Spain and the Netherlands for euro area LCBGs and the United States, the United Kingdom, Switzerland, Denmark, Sweden and Japan for global LCBGs).
Rubric Conclusions Euro area systemic stress contained, but belies a delicate situation Bank-intermediated credit remains scarce and uneven Market-intermediated credit rather abundant and available on rather generous terms Main financial stability risks a combination of legacy and emerging issues A global search for yield continues amid remaining challenges for euro area banks and sovereigns Several policy challenges Micro- and macro-prudential polices need to be considered to ensure that financial intermediaries can withstand a reversal of risk premia Further initiatives needed to monitor and assess vulnerabilities in the growing shadow banking sector Banks balance sheets strengthened further but combination of cyclical and structural challenges to profitability needs to be tackled In the non-financial sector, progress in repairing balance sheets also continues but public debt sustainability far from assured amid changeable market sentiment 1