From the looming prospect of a no-deal Brexit to climate change, the financial sector is facing an array of risks to its stability, European financial regulators warn.
In a new report, the Joint Committee of the European Supervisory Authorities (ESAs) — which includes the region’s regulators for the banking, insurance, pensions and securities sectors — highlighted a number of risks that could spell instability for the financial industry.
In the short-term, there is a great deal of uncertainty about how the U.K.’s planned withdrawal from the European Union (EU) is going to play out.
At the same time, the report also pointed to the impact of persistently low interest rates and flattening yield curves, which may pressure industry profits, and cause firms to take on greater risks as they search for yield.
Longer term, the ESAs said that efforts to transition to a more sustainable economy, along with accompanying environmental, social and governance (ESG)-related risks, creates challenges to certain business models, particularly for firms with large exposures to climate-sensitive sectors.
To address these risks, the regulators called on both policymakers and industry firms to take a number of actions, such as contingency planning to deal with prospect of a no-deal Brexit; managing the risks of continued low interest rates; and stepping up work to identify climate-related risks.
“Financial institutions should incorporate climate risk and other ESG factors into their risk management framework and should play a stewardship role by taking into account the impact of their activities on ESG factors,” the report said.
The report also recommended stress testing for firms’ ESG risks, and added that liquidity stress testing is particularly important in the investment fund sector.
Additionally, the report called for supervisors to pay more attention to the risks in the leveraged loan market, noting, “There is a lack of clarity about the total volume of leveraged loans outstanding and about the ultimate holders of risks of many [collateralized loan obligation] tranches.”
The report also said more work is needed to deal with unprofitable banks and their business models.
“Further investments into financial technologies and exploring opportunities for bank sector consolidation,” represent possible solutions for banks with weak profits, it noted.