Further loss-absorption capacity is available, as banks may operate below the capital level implied by Pillar 2 guidance and may use combined buffer requirements. This decline in activity is expected to be even sharper in the second quarter of the year because lockdown measures were in full force in April. Funds of this type account for half of the sector in terms of AuM, and flows into such funds have not fully recovered to pre-pandemic levels. However, the recent substantial decline in equity markets could weigh on households’ financial asset holdings and housing wealth might also decline. European Central Bank President Christine Lagarde is set to launch a broad review of its policy on Thursday that is likely to see her redefine the ECB's main goal and how to achieve it. Non-banks have rebalanced their portfolios towards higher-yielding but riskier and potentially more illiquid assets after the market turmoil. At the end of 2019, euro area non-bank financial institutions (including MMFs) held around €330 billion of high-yield and non-rated and around €280 billion of BBB-rated debt securities issued by euro area NFCs, compared with around €40 billion and €30 billion held by euro area banks (see Chart 4.2). In line with European Systemic Risk Board (ESRB) recommendations, ESMA’s role in facilitating and coordinating the use of liquidity management tools should be strengthened. After the initial actions to reduce banks’ incentives to constrain credit, prudential authorities took additional steps to prevent banks’ capital positions being unduly weakened by dividend distributions. Focusing on investment-grade and high-yield corporate bond ETFs, investment funds are estimated to hold €17 billion, households €9 billion and ICPFs €7 billion. Firms drew heavily on their revolving credit facilities to access liquidity at the start of the coronavirus crisis and, in many cases, these drawdowns triggered springing covenants. Sources: Crane Data, Refinitiv Lipper IM and ECB calculations.Notes: Left panel: total assets by regulatory fund type and currency for euro area-domiciled money market funds in February 2020, covering around 90% of euro area MMF assets. On 27 March, ECB Banking Supervision recommended that banks refrain from paying out dividends and buying back shares until 1 October 2020, following earlier announcements of temporary capital and operational relief measures. Right panel: PDs refer to the average PDs weighted by loan size of newly issued loans in that quarter within the respective size category. coronavirus testing regime or emergency investments in health care). Higher sovereign spreads might, in turn, cascade to other market segments through banks’ sovereign exposures and through public guarantees on non-financial corporate debt. Governments that provided loan guarantees thereby underwriting credit risk played a crucial role in that context. What the ECB’s Strategy Review Must Do Jan 31, 2020 Lucrezia Reichlin The European Central Bank’s new strategy review must recognize that economists are still a long way from understanding the dynamics of low inflation. Their balance sheets could thus be weakened in the event of renewed stress in sovereign markets. Lessons from the recent stress in the MMF sector should be drawn, including for regulation. For some firms, the sudden collapse in cash flows could translate quickly into liquidity risks and lead to sharply increasing default rates, especially in the high-yield segment. Sources: Bloomberg and ECB calculations.Note: The numbers on the right-hand scale are the cumulative refinancing needs over the next five years in € billions. Sizeable sovereign-bank links in some euro area countries create risks of negative feedback loops arising from sovereign or bank rating downgrades. Euro area banks have significantly increased their lending to non-financial corporations during the pandemic. The robustness of central clearing, a key area of financial sector reform after 2008, also helped avoid wider dysfunction in derivatives markets. Some asset prices could be susceptible to corrections, if GDP and earnings growth outturns are worse than markets appear to expect. As net loan flows to corporates abated over the summer, firms continued to replace the short-term funding they took on in March with longer-dated loans. Dig deeper into the ECB’s activities and discover key topics in simple words and through multimedia. Sensitive sectors account for almost half of total gross value added and unemployment may rise substantially. While one-off factors accounted for most of the ROE decline in 2019, rising impairments represent substantial headwinds for profitability going forward. However, higher volumes of lending to corporates could imply additional credit risk exposures, especially for banks in countries with a high legacy stock of corporate NPLs (see Chart 8, left panel). Euro area banks’ profitability weakened in the first half of 2020 amid the economic fallout from the pandemic. The full sample is not covered for the fourth quarter of 2019 due to reporting lags. , After a brief reversal during the market turmoil in March, investment funds have reverted to their pre-pandemic trend of increasing liquidity risk. The economic impact of the pandemic is highly skewed towards sectors that are directly affected by social distancing measures. Finland and Estonia announced their intention to fully release the systemic risk buffer (SyRB), while the Netherlands announced the reduction of the SyRB for the three banks to which it applies. For the ECB index, these variables include the one-year overnight index swap, the ten-year overnight index swap, the nominal effective exchange rate of the euro vis-à-vis 38 trading partners, and the EURO STOXX index. While a very wide range can be observed across individual euro area banks, the distribution is skewed substantially towards lower values. At the same time, firms continued to shift towards longer-maturity debt which reduced the immediate refinancing needs of businesses and allowed them to lock in the currently favourable credit conditions. One year after the collapse of Lehman Brothers, the largest credit rating agency had downgraded one in six NFCs that were rated BBB prior to the pandemic to high-yield status. This is because lower risk-free rates typically increase the present value of insurers’ liabilities more than that of their assets, especially for life insurers.. Sources: Marsh Global Analytics, Refinitiv and ECB calculations. Exceptionally high spreads between prices for ETFs and prices for their underlying assets (net asset value (NAV) spreads) reflected broader market liquidity issues (see Chapter 2), but may have also reflected frictions in the ETF intermediation chain. Sources: Bloomberg Finance L.P., Refinitiv and ECB calculations.Notes: Left panel: based on national/regional stock price indices. Credit standards reflect backward-looking actual credit standards up to the third quarter of 2020. Sources: European Banking Authority, national authorities, Eurostat, ECB and ECB calculations.Notes: Left panel: data on guaranteed loans capture information for the five largest euro area countries in terms of GDP, i.e. The colours of the bubbles reflect the number of confirmed coronavirus cases in the country as a share of total population. At country level, the estimated CET1 ratio impacts fall in the range of 0.9-3.0 percentage points (see Chart 3.12, right panel). In March, the VIX index, gauging option-implied volatility in the US equity market, reached its highest level on record. In Europe, this hardening of the market is mainly driven by rising underwriting losses from natural catastrophes and other property insurance lines. Transactions in debt securities by ICPFs exhibited similar patterns, although total amounts were smaller. The first earnings releases by euro area banks for the first quarter of 2020 show that higher provisioning has contributed substantially to lower bank profitability. The ECB’s economists have downgraded their growth forecasts in the short term. The narrowing of corporate bond spreads was also in line with a compression in the excess bond premium (see Chart 2.7, right panel). See Hale, T., Webster, S., Petherick, A., Phillips, T. and Kira, B., “Oxford COVID-19 Government Response Tracker”, Blavatnik School of Government, 2020. The targeted review of internal models (TRIM) is a large-scale project conducted by the ECB in close cooperation with the NCAs over 2016-2020. After a temporary increase in cash positions following the March turmoil and despite significant inflows, cash holdings of corporate bond funds have reverted to previous levels (see Chart 4, right panel). Large parts of the global and euro area economies came to a near standstill in early 2020. Sources: Bloomberg Finance L.P., ECB supervisory data and ECB calculations.Notes: Left panel: based on a sample of 20 listed euro area banks and 16 listed US banks. Sources: Bloomberg Finance L.P., ECB and ECB calculations.Notes: The estimation is based on the findings of Andreeva, D., Bochmann, P. and Couaillier, C., “Financial market pressure as an impediment to the usability of regulatory capital buffers”, Macroprudential Bulletin, Issue 11, ECB, October 2020. On aggregate at the start of 2020, banks had capital to withstand a significant increase in loss rates on corporate loans. While government restrictions were broad-based during the first wave of the pandemic, the current restrictions are more focused on activities judged as particularly conducive to spreading the virus, such as public gatherings and travel (see Chart 1.1, middle panel). Market-based valuation indicators such as real estate investment trust (REIT) indices signal a significant decline in market value for the retail and office sectors (see Chart 1.15, left panel). These include fallen angels, given the associated sizeable increase in funding costs (see Chart 2.7, left panel). Countries with a green bubble recorded a decline in overvaluation. Disruption in exchange-traded fund (ETF) markets may have impaired the capacity of investors to raise cash, aggravating existing liquidity shortages. European Central Bank (ECB) President Christine Lagarde (C) speaks during a press conference at the ECB headquarters in Frankfurt, Germany, Jan. 23, 2020. Euro area banks’ profitability outlook has deteriorated further amid gloomy corporate earnings prospects, low interest rates and looming asset quality problems. Looking ahead, full and consistent implementation of all Basel III standards based on the revised timeline remains necessary. Piotr Skolimowski.  In the absence of adequate measures, this may intensify the impact on the economy and in turn the losses for the banking system. Looking ahead, more intense credit risk migration over the next few quarters could put pressure on capital ratios. A large-scale, system-wide increase in NPLs would require a comprehensive approach at the national and EU levels. Whereas global systemically important banks (G-SIBs) slightly increased their issuance volumes, issuance by smaller banks is 25% below that observed in the previous three years, and 8% lower for bail-inable debt. In the second quarter, investment funds increased their holdings of riskier securities: around 70% of new investments were in securities with longer durations (i.e. Despite increasing core revenues during 2019, weak non-interest income was still weighing on revenues. Its aim is to reduce inconsistencies and unwarranted variability when banks use internal models to calculate their risk-weighted assets. Sources: ECB consolidated banking data and ECB calculations.Notes: Left panel: the figures for 2019 from the consolidated banking data refer to the third quarter of 2019. These liquidity risks highlight the need for improved liquidity monitoring in the insurance sector (see Chapter 5). As such, this type of business is expected to be rather resilient to additional payment claims. Looking ahead, a cumulative volume of €145 billion of bank bonds will mature by the end of 2020 and require refinancing (see Chart 3.5, left panel). At the same time, such price growth could make some insurance products increasingly unaffordable. At the same time, these liquidity-providing support measures may become less effective if the economic situation deteriorates further and liquidity constraints morph into solvency issues. The deterioration in banks’ capital ratios reflects low profitability combined with a continued increase in bank assets, and to a lesser degree an increase in average risk-weighted assets, summing up to an overall increase in banks’ risk exposure amounts (see Chart 3.20, left panel). Finally, the experience of recent months shows the benefits of releasable bank capital and suggests rebalancing capital requirements to create macroprudential policy space in the medium term. But an increasing share of corporates in the BBB bucket put on negative rating outlooks and watchlists signals a likely rise in downgrades over the coming quarters (see Chart 2.11, middle panel). Deterioration in the outlook, pointing to a more protracted recovery, as global risks are dominated by economic policy uncertainty due to the pandemic. Sources: Bloomberg Finance L.P., Dealogic, EPFR Global and ECB calculations.Note: Right panel: flows are measured relative to daily initial assets under management and chained together in a similar way to how cumulative fund returns are calculated. Sources: ECB supervisory statistics and ECB calculations.Note: Based on a sample of 116 SIs. Micro- and macroprudential authorities have also acted to support continued bank lending with capital measures amounting to around €140 billion (see Chapter 5). Loan exposures to countries with relevant physical risk drivers ranged between 2% and 20% across significant institutions in the third quarter of 2020. While it is too early to draw firm conclusions, market intelligence suggests some unwillingness on the part of banks to make use of their buffers.  Numerous national authorities also extended restrictions on distributions to less significant institutions (LSIs), thus ensuring consistency between the supervisory treatment of SIs and LSIs. Asset valuation losses in the first quarter of the year and a further decline in interest rates weighed on solvency ratios (see Chapter 2). Notably, where banks judge there to be a “significant increase in credit risk” they must now account for lifetime expected losses. Secular Outlook Takeaways: Escalating Disruption Oct 07, 2020. The European leveraged loan market has experienced increased downgrade rates, especially in March and April, and elevated default rates, although the latter remain below historical highs. 12% of AuM), with institutional funds driving the trend. About half of such issuers lost investment-grade status one year into the financial crisis, compared with one in eight and one in 22 in the BBB and BBB+ buckets, respectively. Flows into and out of euro area funds stabilised from 20 March, as central bank stimulus began to support markets and broader conditions improved (see Chart 3, right panel, in the Overview). ECB Should Speed Up Strategic Review After Fed Move, Praet Says By . Nevertheless, the growth rate of lending to the real economy is expected to remain positive (see Chart 3.19). However, even if banks refinance the total volume of maturing bonds at currently observed secondary market yields, they would still not see an increase in average bond funding costs in the near future. Euro area residential real estate markets have proved resilient to the pandemic so far, as the low interest rate environment has continued to underpin demand, while loan moratoria and job protection schemes have helped to sustain household debt servicing capacity. Examples include measures aimed at improving access to funding in these challenging times, such as the establishment of a European single access point that would provide investors with access to financial and sustainability-related company information and that could be implemented over a relatively short period of time. lower demand for office space), could prompt an extended decline in the euro area CRE market. The ECB strategy review: Walking a narrow path Ignazio Angeloni 03 December 2020 Ahead of the outcome of the EBC's monetary policy strategy review, Ignazio Angeloni describes the narrow path that the central bank walks. As interest margins have compressed, euro area banks have increasingly passed negative rates on to depositors and tried to diversify their revenue sources. Credit spreads do, however, appear tight in view of the near-term economic outlook, particularly for the high-yield segment of the corporate bond market. Similarly, lower-rated sovereigns saw sharp rises in the cost of credit protection, while expectations of a rise in corporate defaults also led to a sharp sell-off in high-yield corporate debt markets (see Chart 3, left panel). Sources: ECB and ECB calculations.Notes: Left panel: monthly transactions January 2006-December 2009 and January 2019-March 2020. This box considers the prospects for fallen angels, and assesses whether the consequences for market access and the risk of downgrade-linked sell-offs are as great as sometimes feared. The latter would result in asset valuation losses and require higher capital charges, thus decreasing solvency capital ratios. While banks saw a moderate improvement in operating profits in 2019, this was not sufficient to offset the negative contribution from one-off factors in other profit and loss items and higher equity capital (see Chart 3.14, left panel). This would be particularly useful for insurers with a vulnerable liquidity profile, such as those that hold derivatives and are subject to margin calls. Beyond the ECB, other European authorities, such as the European Banking Authority and the European Securities and Markets Authority, and international bodies, such as the International Accounting Standards Board and the International Organization of Securities Commissions, have also issued clarifications and guidance on the use of flexibility within the accounting and prudential frameworks. An expected increase in credit risk in the wake of the pandemic weakens the outlook for bank profitability, although in the near-term government schemes may offset some losses. For 2020, impairment charges are expected to increase substantially to account for the deterioration in asset quality arising from the pandemic. Previous issues of the FSR warned of the particular risk from large-scale downgrades of borrowers in the BBB segment in this context, as their downgrades are associated with a loss of investment-grade status. The decomposition assumes that only nominal debt or only nominal GDP changed between 2019 and 2020, affecting debt-to-GDP ratios through the numerator and denominator respectively. The Review has been prepared with the involvement of the ESCB Financial Stability Committee, which assists the decision-making bodies of the ECB in the fulﬁlment of their tasks. International best practice suggests that sound governance and objectives, a clear focus and robust pricing of NPLs upon transfer are instrumental in making such centralised AMCs successful and protecting taxpayers’ money. Supervisory review and Evaluat.. PU chains may also rise if official and demand. Moody ’ s bond and the cost of and the yield of a cycle, some. 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