24/05/2016 Publication
Financial Stability Review
Euro area systemic stress has remained contained despite a challenging external and financial environment.
Rising vulnerabilities stemming from emerging market economies (EMEs), coupled with occasional bouts of financial market turbulence, have tested the resilience of the euro area financial system over the past six months. Overall, the euro area financial system has been able to absorb the tensions, with standard indicators of bank, sovereign and financial stress all standing at low levels in mid-May 2016 (see Chart 1).
Vulnerabilities arising from slowing EME growth prospects have continued to rise since the beginning of the year.
From a euro area financial stability perspective, vulnerabilities stemming from China are a particularly important source of risk given the country’s growing role in global trade and financial markets. Vulnerabilities are, however, also on the rise in several other EMEs, notably those with close ties with China. Contributing further to EME vulnerabilities is the high private sector leverage observed in several of these countries. Private sector indebtedness is at historically high levels in several EMEs and a large share of this debt is denominated in foreign currencies. All in all, a sharper than expected fall in Chinese growth could well lead to a synchronised downturn across other EMEs, particularly commodity-exporting economies. Under such a scenario, the financial systems of advanced economies may be challenged by a reduction in consumer and business confidence, and renewed financial market volatility potentially intensified by sudden stops in or reversals of cross-border capital flows.
Oil prices have been volatile, but remain at low levels, increasingly reflecting weakening demand and higher credit risk.
In general, low oil prices would be beneficial for importing economies such as the euro area as they reduce energy costs. However, exposures of the global financial system to the energy sector have been growing over the past decade and ECB staff calculations point to an increasing role of demand factors in explaining oil price developments. This gradual shift may bode less well for future economic activity than if supply factors had continued to play a large role in declining oil prices. The current low oil prices are below the marginal cost for several oil producers and also below fiscal breakeven prices for a number of oil-exporting countries. Thus, a prolonged period of low oil prices raises questions about the medium-term viability of oil firms business structure and may further spur credit risk concerns and higher premia demanded on riskier global assets.
These developments come amid signs of rising financial market spillovers from EMEs to advanced economies. Prices of risky assets, such as high-yield corporate bonds and equities in EMEs, fell sharply at the turn of the year and there was a significant spillover of the turmoil to advanced economy financial markets and banking sectors. This pattern repeated a tendency of the past few years whereby euro area and other advanced economies’ asset prices have become increasingly sensitive to EME-related developments. The sharp fall in equity prices in EMEs in recent quarters appears closely related to growing macro-financial vulnerabilities, including the higher credit risk related to low and volatile oil prices (see Chart 2).
page source http://www.ecb.europa.eu/
