The European Systemic Risk Board is essentially an offshoot of the European Central Bank. And central banks are normally the last to admit that a crisis is around the corner, if not already here.
The European Systemic Risk Board (ESRB), an advisory body set up in the wake of the Global Financial Crisis to monitor the macro-prudential risks bubbling below the surface of Europe’s economy, issued a “general warning” yesterday (Sept. 29) about the financial system. It is apparently the first time the body has taken such a drastic move since its creation in 2010, when Europe was in the maw of the sovereign debt crisis, and it comes just a day after the Bank of England bailed out highly leveraged pension funds.
Given that the ESRB lacks (in Wikipedia’s words) “juridical personality,” it relies on the European Central Bank (ECB) for both hosting and financial support. The board’s members include representatives from the ECB, national central banks and supervisory authorities of EU member states, and the European Commission. And the chairwoman of the board is Christine Lagarde. In other words, it speaks with the full authority of the EU’s two most powerful institutions, the Commission and the ECB.
Crisis Already Here
Another reason this is important is that central banks are normally the last to admit that a crisis is around the corner. In fact, when they finally sound the alarm, it means the damage is already done and the crisis — which they invariably helped create — is already here. In fact, based on the date at the top of the 15-page document (Sept. 22), it seems to have taken the ESRB a full week to get round to publishing the conclusions of its meeting. Which is ironic given the apparent gravity of its findings. Take these two sentences from the opening paragraph:
“[T]he probability of tail-risk scenarios materialising has increased since the beginning of 2022 and has been exacerbated by recent geopolitical developments. Risks to financial stability may materialise simultaneously, thereby interacting with each other and amplifying each other’s impact.”
What isn’t mentioned, of course, is that those recent geopolitical developments include the European Commission’s mind-watering decision to sanction its most important energy provider, which has, all too predictably, eviscerated Europe’s economy. Following the sabotage of Nordstream 1 and Nordstream 2 earlier this week, the EU is almost totally cut off from Russian gas and it doesn’t have an alternative supplier that can remotely fill the void. The price it will pay for this is likely to be fiendishly high, including in the financial sector and markets.
Three Main Risks
The ESRB identifies three main risks to financial stability:
First, the deterioration in the macroeconomic outlook combined with the tightening of financing conditions implies a renewed rise in balance sheet stress for non-financial corporations (NFCs) and households, especially in sectors and Member States that are most affected by rapidly increasing energy prices. These developments weigh on the debt-servicing capacity of NFCs and households.
No great surprise here. As I warned on August 30, in Europe’s Energy Crisis Is Tipping Legions of Small Businesses Over the Edge, energy-intensive companies, particularly small and mid-size ones, are bearing the brunt of the economic pain of Europe’s entirely self-inflicted energy crisis. Many in-person businesses only managed to weather the lockdowns of 2020-21 by taking on huge amounts of debt, which they now have to pay off. Yet that is becoming harder and harder as the price of energy and most everything else soars.
The ESRB’s second risk:
Risks to financial stability stemming from a sharp fall in asset prices remain severe. This has the potential to trigger large mark-to-market losses, which, in turn, may amplify market volatility and cause liquidity strains. In addition, the increase in the level and volatility of energy and commodity prices has generated large margin calls for participants in these markets. This has created liquidity strains for some participants.
Again, nothing new here. As Yves noted in early September, in Lehman Event” Looms For Europe As Energy Companies Face $1.5 Trillion in Margin Calls, “we are beginning to see, as in 2007 and 2008, that market time moves faster than both real economy and political time, and that has consequences.”
Those consequences include untimely margin calls on energy bets gone bad. As Yves noted in her piece, “It will be some time before the press can ferret out how much of this [is] due to sensible hedges gone bad, stupid hedges gone bad, and speculation gone bad.”
Now for ERSB’s risk number three (comment in parenthesis my own):
The deterioration in macroeconomic prospects weighs on asset quality and the profitability outlook of credit institutions. While the European banking sector as a whole is well capitalised, a pronounced deterioration in the macroeconomic outlook would imply a renewed increase in credit risk at a time when some credit institutions are still in the process of working out COVID-19 pandemic-related asset quality problems. The resilience of credit institutions is also affected by structural factors, including overcapacity, competition from new providers of financial services as well as exposure to cyber and climate risks.
Note the mention of “overcapacity,” one of the ECB’s biggest bugbears. For the central bank, Europe has too many small banks, as opposed to too many banks that are simply too big to exist…
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Nick Corbishley 