ESRB General Board meeting in Frankfurt

The General Board of the European Systemic Risk Board (ESRB) held its 19th regular meeting on 17 September 2015

The General Board highlighted the global repricing of risk premia and a possible weakening of financial institutions’ balance sheets – including insurers, banks and shadow banking – as key EU financial stability concerns. The global environment of low interest rates and low risk premia, while necessary to support the still sluggish nominal growth, is one common driver of the current risk situation and may have unintended effects on some economic sectors or in some countries that may require the adoption of targeted macroprudential measures. Recent developments in key emerging market economies have increased uncertainty and the probability of a repricing of risk premia in global financial markets has caused significant volatility in global and European financial markets. Although direct bank exposures to emerging markets are significant in only a few EU countries, other transmission channels – such as broader confidence effects on the global economic recovery as well as second-round market effects – could prove to be more substantial. Furthermore, the General Board discussed the need to monitor medium-term risks related to public and private debt sustainability.

The insurance sector plays an important role in reducing systemic vulnerabilities by diversifying risks and providing long-term investments. Nevertheless, the insurance industry may also cause or amplify systemic risk in both cyclical and structural terms, especially for business activities outside traditional insurance. Ensuring that macroprudential authorities have appropriate instruments to mitigate these risks is therefore crucial. A comprehensive report on the macroprudential aspects of insurance will be published by the ESRB in the forthcoming months. In the short term, priority must be given to a full implementation of Solvency II. The use of transitional measures should be subject to transparency requirements and be authorised by supervisors with careful consideration of the industry’s capacity to withstand stress in current market conditions.

Furthermore, the General Board discussed risks related to the real estate sector. Given the history of banking sector crises originating from real estate developments, the ESRB has undertaken work to better understand how structural features of real estate markets in the EU are linked to financial stability. Structural features of residential real estate markets in the EU vary widely, with potentially significant implications for financial stability. Preliminary analysis indicates that high loan-to-value ratios, a favourable tax treatment of housing and high levels of bank leverage may increase the vulnerability of countries to distress in the real estate sector. Commercial real estate markets differ fundamentally from residential markets and pose distinct risks to financial stability. Whereas several countries have taken macroprudential action in residential real estate, such action has been rare in commercial real estate. The challenges in terms of data for financial stability monitoring are also significantly greater in the commercial real estate sector. The outcome of the ESRB’s work on real estate will be published in the coming months. Finally, given the relevance of data gaps in residential and commercial real estate markets, the General Board decided to start the preparatory work on issues concerning statistical definitions and gaps related to real estate data.

Finally, the General Board noted that adequate recovery and resolution regimes for insurance companies and central counterparties are important building blocks of a sound financial stability architecture. Appropriately designed regimes for recovery and resolution may reduce the systemic impact of a failing financial entity. As these regimes influence the incentives faced by the relevant entities and their counterparties, they may also reduce the risk of an entity failing in the first place. The General Board sees therefore the need to establish an EU-wide recovery and resolution frameworks for insurance corporations and central counterparties. In the case of insurance companies, the application of a resolution regime should be based on the proportionality principle and only be used where ordinary winding-up procedures cannot achieve the resolution objectives. In the case of central counterparties, the preservation of critical clearing services, the protection of public funds and the limitation of wider systemic consequences would be some of the key objectives of the legal framework to be established. . The appropriate design of recovery and resolution regimes for insurance and central counterparties would help strengthen financial stability at both the EU and the national level.

The ESRB releases the thirteenth issue of its risk dashboard today. The risk dashboard is a set of quantitative and qualitative indicators of systemic risk in the EU financial system.

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