The three European Supervisory Authorities (ESA), the EBA, EIOPA and ESMA, have warned that the deteriorating economic outlook, high inflation and rising energy prices have increase vulnerabilities across the financial sectors.

In their autumn 2022 joint risk report, the ESAs advised national supervisors, financial institutions and market participants to prepare for challenges ahead.

They noted that the post-pandemic recovery in Europe had “dwindled” due to the Russian invasion of Ukraine, which had added to pre-existing inflationary pressures, and the risk of persistent inflation and stagflation had increased.

These factors, alongside the deteriorated economic outlook, have “significantly impacted” the risk environment of the financial sector, with financial market volatility increasing across the board due to the high level of uncertainty.

The ESAs noted that, following a period of low interest rates, central banks are tightening monetary policy.

“The combination of higher financing costs and lower economic output may put pressure on government, corporate and household debt refinancing while also negatively impacting the credit quality of financial institutions’ loan portfolios,” the report warned.

“The reduction of real returns through higher inflation could lead investors to higher risk-taking at a time when rate rises are setting in motion a far-reaching rebalancing of portfolios.”

Concerns were also raised that financial institutions will face increased operational challenges associated with heightened cyber risks and the implementation of sanctions against Russia, although the ESAs stated that the financial system has been resilient to date despite the uncertainty.

The Joint Committee of the ESAs urged financial institutions and supervisors to continue to be prepared for a deterioration in asset quality in the financial sector and to monitor developments, while it warned that the impact of further increases in policy rates and potential sudden increases in risk premia on financial institutions and market participants should be closely monitored.

Financial institutions and supervisors were also encouraged to monitor the impact of inflation risks, and to continue to carefully manage environmental risks and cyber risks to address threats to information security and business continuity.

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