The ECB published its December 2006 Financial Stability Review, warning that the durability of euro area banking sector profitability could be tested in the period ahead. “There is some concern that intense competition could have encouraged banks to loosen credit standards, which could have left them with greater exposures to the risk of adverse credit events”, the review says.
“While the direct market risks faced by large euro area banks are likely to prove manageable, banks may still face risks in other market-related business activities as well as counterparty risks from both non-financial and non-bank financial firms where risk management practices may be less advanced”, it continues.
The ECB also states that “long-term interest rates and risk premia have been driven too low in some financial markets” and warns that “asset valuations could prove vulnerable to several potential adverse disturbances, which could leave banks exposed to greater than normal risks, especially if market events were to challenge the loss-absorption capacities of their counterparties.”
Also, large global financial imbalances remain a global source of medium-term risk for the stability of financial systems, the report states. In the euro area, “rapid re-leveraging in some parts of the corporate sector and growing household sector financial imbalances will require close monitoring in the period ahead.”
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