EU banking sector stability

The European Central Bank has today published a report on EU banking sector stability, prepared by the Banking Supervision Committee of the European System of Central Banks. This Committee comprises representatives of EU national central banks and banking supervisory authorities and the ECB. Such a report has been published regularly since 2003.

The report examines the implications of recent macroeconomic and financial market developments for the performance of the banking sectors of the 25 EU Member States (EU-25) in 2004 and the first half of 2005 and for their risk outlook. A prudent approach to analysing banking sector stability requires the identification and evaluation of the implications for banks of plausible sources of downside risks to the most probable outcome. In this vein, the report also provides an assessment of the financial soundness and shock-absorbing capacity of banks. This report includes, for the first time, key indicators for each country’s banking sector in its statistical annex.

The contents of the report can be summarised as follows:

Profitability and solvency of EU-25 banks in 2004 and the first half of 2005

EU banks’ profitability continued to improve, consolidating upon the recovery that began in 2003. Overall, notwithstanding some differences across countries, EU banking sectors benefited from generally benign credit and liquidity conditions. The main drivers of the further improvement in profitability since 2003 were a reduction in the flow of provisions, an increase in lending to households (especially for housing purposes) and a recovery in lending to non-financial corporations, including small- and medium-sized enterprises. At the same time, cost-cutting, which had been a significant contributor to the strengthening of profitability in 2003, abated.

EU-25 banks’ risk outlook

There are both downside and upside risks to the overall positive outlook for banks. On the negative side, there are uncertainties surrounding the macroeconomic outlook (particularly related to the rise in oil prices), the persistence of large global financial imbalances and the increasing household sector indebtedness, although the still generally conservative loan-to-value ratios for households and the overall good condition of household balance sheets make a material deterioration in households’ creditworthiness rather unlikely. Concerning the effect of a potential abrupt unwinding of global imbalances, if it were to materialise, its impact would likely be limited, as EU banks’ direct exposure to exchange rate risk remains contained and there are indications that banks’ direct exposure to interest rate risk is in general small in relation to banks’ capital. On the positive side, banks’ risk management systems have improved, although the ways in which risks have been redistributed by credit risk transfer products, both within the banking system and between banks and other financial institutions, have yet to be tested by a stress situation. Nonetheless, banks’ favourable financial results in 2004 and the first half of 2005 have provided them with resources to increase their buffers.

The generally positive assessment of the financial condition of banks outlined in the report is also corroborated by a set of forward-looking market-based indicators for a sample of large EU-25 banks. These indicators have continued to improve since 2003, pointing to an ongoing positive reassessment of the outlook for banks’ profitability and for their operating environment in the near future. This can also be seen as a sign that the risks facing banks are manageable for the majority of large banks in the EU.

Further information

This report can be downloaded from the “Publications” section of the ECB’s website (http://www.ecb.europa.eu/pub). Printed copies are also available free of charge from the ECB’s Press and Information Division at the address given below.