March 27, 2019 / 2:15 PM / 4 months ago

EU financial stability may be hurt if markets reprice risk - ESRB document

BRUSSELS, March 27 (Reuters) - The European Union’s financial stability could be hurt if global markets reprice risk premiums in the face of concerns over trade tensions, Brexit and a lack of clarity over government policy in Italy, a confidential EU document seen by Reuters showed.

The report was prepared by the European Systemic Risk Board (ESRB), chaired by European Central Bank President Mario Draghi, for a meeting of euro zone economic officials ahead of next week’s monthly meeting of the bloc’s finance ministers.

“Risks to EU financial stability are assessed to have remained at elevated levels,” the ESRB said in the document, listing as its main concerns the mispricing of risks by financial operators and their possible repricing of premia as growth slows and interest rates remain low.

The ESRB said these risks were mostly caused by global trade tensions, the weakness of emerging economies, Brexit and “policy uncertainties in Italy” where a eurosceptic government has embarked on high-spending plans with little impact on growth despite the country’s huge debt at 130 percent of output.

These uncertainties could hurt the balance sheets of EU financial institutions, the ESRB said in the document, stressing that EU banks, life insurers and pension schemes faced increased risks in the current low-yield environment.

Amid an unexpected slowdown, the ECB put its plans to normalise monetary policy on hold this month, delaying a rate hike from record lows until next year and even further if necessary.

Banks could face challenges in funding, also in foreign currencies, as markets become more risk-averse at a moment when lenders have to meet refinancing needs and requirements to raise buffers to absorb losses.

High levels of public and private debt also remain risks for financial stability as the capacity to absorb shocks is “limited”, the ESRB said.

It also warned EU economic experts of dangers posed by the EU shadow banking system, which includes investment banks, money market and hedge funds, as its growing size and complexity makes it difficult to gauge its exposure to risks.

A repricing in global financial markets could trigger “fire sales and liquidity squeezes” in the sector, the report warned, saying that this in turn posed wider concerns over financial stability and contagion risks. (Reporting by Francesco Guarascio; Editing by Hugh Lawson)

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