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: European Central Bank warns on heightened risks to financial stability

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Financial-stability risks are increasing in Europe, and the uneven impact of the COVID-19 pandemic means that they have become concentrated in specific industries and countries, the European Central Bank said on Wednesday in its latest Financial Stability Review.

  • The ECB warned, in particular, about higher levels of corporate debt throughout the region. Notably, “a higher corporate debt burden in countries with larger services sectors could increase pressure on governments and banks in these countries,” said its vice-president Luis de Guindos in a statement.
  • As governments withdraw the massive support they extended to businesses during the pandemic, “considerably higher insolvency rates than before the pandemic cannot be ruled out, especially in certain euro area countries,” the ECB said.
  • The central bank also warned about “the potential for abrupt asset price corrections” after the financial markets’ rallies of the last six months, coupled with rising prices in the European residential market.
  • The banking sector’s market valuation may have risen in the past few months, but bank profitability remains low and prospects for lending demands are uncertain, the ECB said, calling for an increase in bad loans provisions.
  • As for the nonbanking financial sector (aka ‘shadow banking’), the ECB warned that it has “large exposures to corporates with weak fundamentals and [is] sensitive to a yield shock.”

Read: Inflation Shot Up in April in the U.K. Here’s Why This Won’t Last.

The outlook. The number of bankruptcies fell by 18% in the European Union in 2020, as governments offered blanket protections to all businesses to help them cushion the COVID-19 pandemic impact. As the economy recovers, the number of zombie companies will become apparent, creating a new set of policy problems.

The challenge for governments will be to identify the companies that do need to be further supported — through more targeted measures — and those who must be left to fail.

Read: This signal is telling investors that highflying stocks are ready to fall back to Earth, says fund manager

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