Vtor Constncio

ECB Financial
Stability Review
May 2015

28 May 2015

Press briefing presentation

Rubric
Recent developments

Measures of financial market, banking sector and sovereign

stress in the euro area
(Jan. 2011 May 2015)

Euro area financial system stress,

as extracted from market
indicators, has remained overall
low over the past six months,
despite shorter periods of higher
financial market volatility

probability of default of two or more LCBGs (percentage probability;

left-hand scale)
composite indicator of systemic stress in financial markets (right-hand
scale)
composite indicator of systemic stress in sovereign bond markets
(right-hand scale)

28

0.7

November FSR

Indicators of stress among

euro area banks and
sovereigns remain at low
levels
Systemic stress across the
broader financial system also
contained

24

0.6

20

0.5

16

0.4

12

0.3

0.2

0.1

0
Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15

0.0

Sources: Bloomberg and ECB calculations.

Notes: (i) Probability of default of two or more LCBGs refers to the probability of
simultaneous defaults in sample of 15 large and complex banking groups (LCBGs) over a
one-year horizon. (ii) For further details on the CISS methodology, see Hollo, D., Kremer,
M. and Lo Duca, M., CISS a composite indicator of systemic stress in the financial
system, Working Paper Series, No 1426, ECB, March 2012.
2

Rubric
Recent developments

Euro area financial and economic

indicators signal a stark dichotomy
in risk-taking

High financial risk-taking, low sovereign yields, subdued

credit growth coupled with subdued economic risktaking
(Jan. 2008 to Mar. 2015, index: Jan. 2008 = 100)
bank credit to corporates

High financial risk-taking. The

prices of financial assets in most
segments have continued to rise

real fixed investment

EURO STOXX index
euro area corporate bond yields (right-hand scale)
130

9
November FSR

120

but, the recent increases in

asset prices have not been
accompanied by growing
leverage in the banking sector
nor by rapid private sector credit
expansion.
Economic risk-taking in the euro
area is clearly lagging.

110

100

90

80

70

60

50

40
2008

0
2009

2010

2011

2012

2013

Sources: Thomson Reuters Datastream and ECB.

Note: The Iboxx euro corporate bond all maturity index is employed.

2014

2015

Main
Rubric risks for the euro area financial system

1. Abrupt reversal of compressed global risk

premia amplified by low secondary market
liquidity
2. Weak profitability prospects for banks and
insurers
in
a
low
nominal
growth
environment, amid slow progress in resolving
problem assets
3. Rise of debt sustainability concerns in the
sovereign and corporate sectors amid low
nominal growth
4. Prospective stress and contagion effects in a
rapidly growing shadow banking sector

Rubric
Main risks and vulnerabilities
Risk 1 - Abrupt reversal of compressed global risk premia amplified by low
secondary market liquidity
Stock prices broadly in line with fundamentals in the
euro area, valuations somewhat stretched for US stock
prices
(Jan. 1983 - May 2015, yellow shaded area represents the
25-75 percentiles)

Valuation estimates for euro area residential and prime

commercial property above their long-term average (Q1
2009 - Q3 2014; average of price changes in Austria, France,
Germany, Ireland, the Netherlands and Spain)
35
Residential property
30
25
20
15
10
5
0
-5
-10
-15
-20
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
35
Commercial property
30
25
20
15
10
5
0
-5
-10
-15
-20
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

euro area CAPE, 25th -75th percentile

US CAPE

60

50

40

30

20

10

0
1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013

Sources: Jones Lang Lasalle, ECB and ECB calculations.

Sources: Thomson Reuters Datastream, Robert Shiller's homepage

(http://www.econ.yale.edu/~shiller/data.htm) and ECB calculations.
Notes: Cyclically adjusted price/earnings (CAPE) ratios for the euro area
and the United States. The cyclically adjusted price/earnings ratios for the
euro area are imputed from Datastream's stock market indices. The US
CAPE is taken from Robert Shiller's homepage.
.

Note: Valuation estimates for residential property prices are based on four
different valuation methods: price-to-rent ratio, price-to-income ratio and two
model-based methods. For details of the methodology, see Box 3 in ECB,
Financial Stability Review, June 2011. For further details on valuation estimates
for prime commercial property, see Box 6 in ECB, Financial Stability Review,
December 2011.
.

Rubric
Main risks and vulnerabilities
Risk 2 - Weak profitability prospects for banks and insurers in a low nominal
growth environment, amid slow progress in resolving problem assets
while the cyclical downturn in certain areas has
contributed to a high outstanding stock of nonperforming assets
(2006 2014; annual percentage changes (GDP); median
NPLs as a share of total loans, median ROE, vulnerable
countries)

Non-performing loans broadly stable in the majority of

euro area countries
(2006 2014; annual percentage changes (GDP); median
NPLs as a share of total loans, median ROE, non-vulnerable
countries)
NPLs (left-hand scale)

NPLs (left-hand scale)

ROE (left-hand scale)

ROE (left-hand scale)

GDP (right-hand scale)

GDP (right-hand scale)

20

15

20

15

10

10
2

5
0

5
0

-5

-5

-2

-2
-10

-10
-4

-15
-20
2007

2008

2009

2010

2011

2012

2013

-6

-20

-6
2006

-4

-15

2006

2014

2007

2008

2009

2010

2011

2012

2013

2014

Sources: SNL Financial, Eurostat and ECB calculations.

Sources: SNL Financial, Eurostat and ECB calculations.

Note: Return on equity (ROE), non-performing loans (NPLs) and GDP

growth in non-vulnerable countries. Euro area countries excluding Spain,
Italy, Portugal, Greece, Cyprus and Slovenia.

Note: Return on equity (ROE), non-performing loans (NPLs) and GDP

growth in vulnerable countries. Vulnerable countries: Spain, Italy,
Portugal, Greece, Cyprus and Slovenia.

Rubric
Main risks and vulnerabilities
Risk 2 - Weak profitability prospects for banks and insurers in a low nominal
growth environment, amid slow progress in resolving problem assets
Currently, EU bank profitability is mainly being
suppressed by weak cyclical factors

The importance of cyclical developments for EU bank

profitability is confirmed when comparing it with that of
their US peers
(end-2013; ratios and percentages)

(1994 2013; ratios and percentages)

sample average

CR5 (+)

Herfindahl
index (+)

EU banks 2013

size (-)
200

2013 average

US banks 2013
CR5 (+)

equity ratio (+)

150

250

equity ratio (+)

200
150

100
LLP over total
loans (-)

50

credit over
GDP (+)

100

LLP over total

loans (-)

50
0

-50

-50

-100

loan growth (+)

credit over
GDP (+)

real GDP
growth (+)
real GDP
growth (+)

loan growth (+)

inefficiency (-)
diversification
(-)

diversification
(-)

retail ratio (+)

inefficiency (-)

retail ratio (+)

Sources: Bloomberg, Eurostat, SNL Financial and ECB calculations.

Sources: Bloomberg, Eurostat, SNL Financial and ECB calculations.

Notes: Current state of EU banks profitability determinants against
historical benchmarks (sample average). The historical averages have
been normalised to 100. Current values of the indicators are measured in
terms of deviations from historical averages.
.

size (-)
300

Notes: Current state of EU banks profitability determinants against their US

peers (US measures normalised to 100). The US-based indicators have
been normalised to 100. Current values of the EU-based indicators are
measured in terms of deviations from the US indicators. 24 large US banks
are considered.

Rubric
Main risks and vulnerabilities
Risk 2 - Weak profitability prospects for banks and insurers in a low nominal
growth environment, amid slow progress in resolving problem assets
Slightly higher valuations of euro area banks in 2015,
but they still trade at a discount vis--vis their US peers
(Jan. 2007 May 2015, grey shaded area represents the
difference between United States and the euro area)

Still substantial gap between euro area banks cost of

equity and the return on equity
(Q1 1999 - Q4 2014)

Inter-quartile range ROE

Inter-quartile range COE

median COE

median ROE

euro area
United States

3.0

25
20

2.5

15
2.0

10
5

1.5

0
1.0

-5
-10

0.5

-15
-20

0.0
-0.5
2007

Sources: Bloomberg, Thomson Reuters, Consensus and ECB

calculations.

2008

2009

2010

2011

2012

2013

Source: Thomson Reuters Datastream.

Note: Price-to-book ratio for euro area and US banks

Note: Cost of equity (COE) and return on equity (ROE) for a large sample
of listed euro area banks. Based on the sample of 33 euro area banks
included in the Euro STOXX index.
8

2014

2015

Rubric
Main risks and vulnerabilities
Risk 2 - Weak profitability prospects for banks and insurers in a low nominal
growth environment, amid slow progress in resolving problem assets
Despite the challenging environment, market-based
indicators suggest a stable outlook for euro area
insurers
(Q1 2002 2016)

Insurance companies investment portfolios still

dominated by fixed income securities
(2011 2014; percentage of total investments; weighted
averages)

2011

2012

2013

2014

50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%

Sources: JPMorgan Cazenove, individual institutions financial reports

and ECB calculations.
Note: Based on available data for 15 large euro area insurers and
reinsurers.

Sources: Thomson Reuters, Datastream, ECB and ECB calculations.

Rubric
Main risks and vulnerabilities
Risk 3 - Rise of debt sustainability concerns in the sovereign and corporate
sectors amid low nominal growth
Euro area debt remains elevated also in the private
sector
(2000 2014; Debt as a percentage of GDP)

2015 financing needs are substantial for several euro area

countries
(2015; percentage of GDP; percentages)

households
non-financial corporations
government

25
Gross financing needs

120
IT

20
ES
FR

15

100
PT

80

BE

EA
NL

10
SK
LT
5
LV

FI DE

60

SI

GR

AT

40

MT
IE

20

LU

0
0

50

100
150
Gross general government debt

200

Sources: European Commission and Bloomberg.

Note: The size of the bubble reflects the 2015 year-to-date average tenyear government bond yield.

0
2000

2002

2004

2006

2008

2010

2012

2014

Sources: Eurostat and ECB.

Notes: Based on ESA 2010 standards, except for general government debt
from Q1 2000 to Q4 2005, for which the ESA 1995 has been used. Nonfinancial corporate debt is unconsolidated, comprising loans (incl. intrasectoral loans), debt securities and pension reserves. For the household
10sector, the series ends in Q3 2014; for the remaining series, the last data
points are for Q4 2014.

Rubric
Main risks and vulnerabilities
Risk 4 - Prospective stress and contagion effects in a rapidly growing shadow
banking sector
Steady increase in the euro shadow banking sector
suggests that vulnerabilities are likely to have been
growing more in this segment
(Q4 2008 Q4 2014; index: Q4 2008 = 100)

Bond and real estate funds most likely to amplify shocks

and impose externalities on the system
(Data as of Q4-2014), x-axis: Leverage (total assets / shares
and units issued), y-axis: Liquidity mismatch (shares and
units issued / liquid assets)

shadow banks: hedge funds

5.0

shadow banks: investment funds (excl. money market funds)

shadow banks: overall

4.5

banks

Bond funds
3.0 trillion

4.0
Shares issued to liquid assets

260
220
180
140
100
60
20
2008

Real estate
funds
0.4 trillion

3.5
3.0

MMFs
0.9 trillion

2.5
2.0

2010

2011

2012

2013

1.0

0.0
1.00

2014

Mixed funds
2.1 trillion

1.5

0.5

2009

Hedge funds
0.2 trillion

Equity funds
2.3 trillion

Other funds
0.5 trillion

1.10

1.20

1.30

Leverage

Sources: ECB and ECB calculations.

Sources: ECB and ECB calculations.

Note: Assets of selected euro area financial sectors

Note: Liquidity mismatch and leverage among euro area money market
and investment funds. Bubble size: total assets in EUR trillions
11

Rubric
Conclusions
Euro area systemic stress contained but with vulnerabilities
Downside risks to economic growth have receded
and asset prices have increased over the past six months but still without
generalised overvaluations
while lower-than-average turnover ratios and deal sizes imply high price
sensitivity to market shocks
Market-intermediated credit rather abundant and available on rather
generous terms
Several policy challenges
The need for a strict focus of the ECB's monetary policy on its price stability
mandate, together with country and sector challenges, suggests a strong role
for macroprudential policy in dealing with any systemic risk related to
potential asset price imbalances
Further initiatives needed to monitor and assess vulnerabilities in the growing
shadow banking sector
Banks balance sheets strengthened further but combination of cyclical and
structural challenges to profitability needs to be tackled
Public and private debt ratios still high and in need of correction with potential
sustainability challenges if higher nominal growth not sustained
12