ECB low interest rates have supported economic activity but lead to excessive risk-taking. Credit: Reuters.
The European Central Bank has warned that financial stability in the euro area remains challenging.
In a report released on Wednesday morning, the ECB said its policy of low interest rates had supported economic activity, but that there were signs it had led to excessive risk-taking by non-banking financial institutions.
President Christine Lagarde took over from Mario Draghi in November. (Credit: Reuters)
This is the ECB's first financial stability review released under the leadership of its new President Christine Lagarde, who took over from Mario Draghi at the beginning of November. Before leaving office, Draghi defended the use of negative interest rates in monetary policy. Rates remain at a record low of minus 0.5%.
Wednesday's report highlights the region's key vulnerabilities as investment funds and insurance companies that are taking more financial risks, and notes that they are becoming an increasingly important part of the real economy. The ECB warned that some companies have high levels of debt, which would leave them vulnerable to sudden changes in the financial environment.
Mario Draghi defended the use of negative interest rates before leaving office. (Credit: Reuters)
In a statement, the ECB said: "In the event of a sudden repricing of financial assets, growing credit and liquidity risk in some parts of the euro area non-bank financial sector – coupled with higher leverage in investment funds – may lead non-banks to respond in ways that cause stress to spread to the wider financial system."
Vice-President of the ECB, Luis de Guindos said: "While the low interest rate environment supports the overall economy, we also note an increase in risk-taking which warrants continuous and close monitoring. Authorities should use available tools to address the build-up of vulnerabilities where possible."
Vice-President Luis de Guindos says that while low rates support the economy, risk taking has significantly increased (Credit: Reuters)
The report also says that banks are still struggling with low profitability but have become more resilient on average. It says consolidation between European banks could help financial stability.
It also reports that the economic outlook for the euro area has deteriorated "with growth expected to remain subdued for longer." This is described as reflecting a combination of factors including the weakness of global trade. The report also notes the effect of political and policy uncertainties around the world, most notably trade disputes and the lack of clarity regarding the future trading relationship between the UK and the EU after Brexit.
The ECB's Financial Stability reviews are released twice a year and aim to promote awareness of economic risks in the euro area among policymakers, the financial industry and the public. Its ultimate goal is to promote financial stability by creating a system that is capable of withstanding economic shocks.