The European Supervisory Authorities (EBA, EIOPA and ESMA) have called for “vigilance from all financial market participants in the wake of “heightened uncertainty” in the economy.

Publishing its Autumn 2023 Joint Committee Report, noted that recent years have presented a series of adverse events, such as the Russian aggression against Ukraine, the energy crisis, and US mid-sized banks turmoil in March 2023, which it said most financial institutions have navigated well.

“Nonetheless, the European economy continues to experience a period of heightened uncertainty which presents material financial stability risks that necessitate vigilance from all financial market participants. The economic outlook remains fragile, not least amid persistently elevated geopolitical risks, high inflation, and an uncertain macro-financial outlook,” the report said.

Furthermore, it stated that market implications from turmoil in the banking sector in March also highlight the continuing sensitivity of the European financial system to exogenous shocks and the high ongoing market uncertainty. Swedish pension company, Alecta, lost SEK 20bn as a result of the March US banking crisis and is now being investigated by the Swedish Financial Supervisory Authority as a result.

Against the backdrop of these risks and vulnerabilities, the Joint Committee of the ESAs advises national competent authorities, financial institutions and market participants to take several actions.

For example, financial institutions and supervisors should closely monitor the broader impact from strong increases in policy interest rates and sudden rises in risk premia and account for in risk management. They should also remain prepared for a deterioration in asset quality in the financial sector.

The ESAs further advised financial institutions and supervisors to be aware of, and closely monitor, the impact of inflation risk. “Inflation not only impacts financial institutions by its effects on asset quality and valuation but also through rising expenditures and rising funding costs as a result of higher interest rates and other channels,” the ESAs stated.

Finally, financial institutions should place high importance on effective risk management and governance arrangements, in particular in relation to liquidity risk and interest rate risk, as recent problems in the US and Switzerland highlight. The report stated that financial institutions need to remain resilient to the impact of future substantial interest rate changes.

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