The three European Supervisory Authorities (EBA, EIOPA and ESMA - ESAs) have issued their Autumn 2023 Joint Committee Report on risks and vulnerabilities in the EU financial system.

In a statement on 18 September, underlining "continued high economic uncertainty", the ESAs warned national supervisors of the financial stability risks stemming from the heightened uncertainty, and called for vigilance from all financial market participants.

"Recent years have presented a series of adverse events, i.e., the Russian aggression against Ukraine, the energy crisis, and US mid-sized banks turmoil in March 2023, which 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.

"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. Market nervousness and bad news about parts of the financial system could spread rapidly and lead to a general jump in risk aversion."

The ESAs further said the increase in interest rates generated heterogeneous impacts on the financial sector. This resulted in increased net interest income for banks, reduced profitability for insurers and liquidity risks for the asset management sector.

Against the backdrop of these risks and vulnerabilities, the Joint Committee of the ESAs has advised national competent authorities, financial institutions and market participants to take the following policy actions:

  • financial institutions and supervisors should closely monitor the broader impact from strong increases in policy interest rates and sudden rises in risk premia and accounted for in risk management;
  • financial institutions and supervisors should remain prepared for a deterioration in asset quality in the financial sector. Supervisors should continue to closely monitor asset quality and loan loss provisioning;
  • financial institutions and supervisors should 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;
  • 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. Financial institutions need to remain resilient to the impact of future substantial interest rate changes.