BERLIN (MNI) – Despite some improvements, there still exist risks
and uncertainties regarding the stability of the banking sector in the
European Union, the European Central Bank said in its sector stability
report released Wednesday.

Notwithstanding recent improvements in the macroeconomic
environment in many EU countries, “risks to banking sector stability
remain,” the report stated. “The outlook for the EU banking sector is
still surrounded by some degree of uncertainty.”

In particular, in view of the subdued outlook for banking sector
profitability and persisting funding pressures in some segments of the
sector, the possibility of both a setback in the recent recovery in
profitability and an adverse effect on the supply of credit to the
economy remain important risks, the ECB warned.

The central bank pointed to a challenging outlook for household
sector credit risk owing to the sluggish economic recovery, high
unemployment in several countries, tight credit conditions and, in some
countries, the further decline in housing prices.

“Hence, banks are likely to be faced with further losses on their
household lending portfolios, especially on consumer loans,” it said.

“Risks arising from the corporate sector seem to have declined
somewhat since the publication of the 2009 report on EU banking sector
stability, although they remain substantial,” the ECB observed.

Corporate profitability has recovered slightly and could improve
further over the next six months, giving firms the means to reduce their
high indebtedness, the central bank said.

Corporate insolvencies are expected to rise further, albeit
moderately, during the next few months, and expected default frequencies
have fallen to levels last seen around the second half of 2008, although
they remain above pre-crisis levels, the report noted.

Credit conditions for non-financial firms remain tight, especially
for small and medium-sized enterprises, the ECB remarked.

“Should the economic recovery be weaker than currently projected,
this could increase the risk of further losses for banks stemming from
their exposures to the corporate sector, especially in those countries
that are already facing market pressure,” it said.

“Looking ahead, one area of concern is the risk of bank bond
issuance being crowded out as a result of the significant increase in
financing needs of several EU governments in the period ahead,” the ECB

In addition, banks may also face the prospect of higher funding
costs owing to the need to “term out” their funding and because of
increasing competitive pressures in markets for retail deposits, it

“Moreover, the continued reliance of some banks on central bank
refinancing facilities remains a source of concern,” it stressed.

At the same time, the aggregate results of the EU-wide stress tests
seem to suggest that banks have, overall, sufficient loss-absorption
capacity for possible further shocks, it said.

Furthermore, the commitment by national authorities to monitor
capital-raising plans by the weakest banks and to support the banking
sector where market resources are not available provide an additional
buffer of resilience for the European banking system, the report stated.

In its report on EU banking structures also released today the ECB
said it is clear that the banking landscape will be transformed over the
medium term. The diversified business model is expected to gain in
importance and banks are expected to conduct safer funding policies, it

However, the current environment is subject to many uncertainties,
which may have also an impact on the evolution of the EU banking sector,
the ECB cautioned.

–Berlin bureau: +49-30-22 62 05 80; email:

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