Tighter credit conditions in the euro zone, sluggish growth and increased geopolitical tensions are weighing on the outlook for financial stability, the European Central Bank warns in a report published on Wednesday.
The weak economic outlook and the consequences of high inflation are putting a severe test on the ability of individuals, businesses and governments to repay their debt, declared Luis de Guindos, Vice-President of the ECB, in introduction to the semi-annual report on the financial stability of the monetary institution.
Economic forecasts for the euro zone have been revised downward, confirming significant downside risks, according to the report.
A sharper economic slowdown than currently expected could prove difficult for euro zone companies, particularly if their debt levels are high, their profits modest and their interest coverage ratios low, the report insists.
Eurozone banks have demonstrated resilience to shocks since the pandemic and their profitability has increased.
But their costs are expected to increase, in particular because they will have to face a drop in loan volumes resulting from the increase in interest rates led by the ECB to fight inflation.
For their part, financial markets and non-bank financial institutions such as investment funds remain vulnerable and must strengthen their resilience, recommends the ECB.
The Frankfurt institution has raised its key rates to an unprecedented extent, making ten increases in a row since July 2022 to combat inflation. Last month, it paused in this monetary tightening, leaving its rates unchanged, but without ruling out a new turn of the screw if necessary.
It is essential that we remain vigilant as the economy moves toward an environment of higher interest rates coupled with growing uncertainties and geopolitical tensions, added Mr. Guindos.
Geopolitical tensions in the Middle East, linked to the war between Israel and Hamas, could have negative repercussions on the supply of energy raw materials if the conflict worsens further, the report suggests. Furthermore, they could create risk aversion in financial markets and undermine confidence in the economy.