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European Banking System: Challenges and Risks

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The European banking system faces various risks and challenges that threaten its stability. This report provides a comprehensive overview of these issues and discusses potential solutions to mitigate them.

Economic Risks

The European economy is experiencing high inflation and rising interest rates, which could have several negative consequences:

  • Eroding real disposable income, reducing credit quality
  • Increasing debt-servicing costs for non-financial corporations and households

Impact on Banks

A rise in market interest rates could lead to significant changes in the financial health of banks:

  • A 400-basis-point increase in market interest rates could drive up non-financial corporations’ median gross interest burden by between 2.9 pp and 6.8 pp, and the percentage of corporate debt held by corporations under high financial pressure by between 6.5 pp and 8.9 pp.
  • A 450-basis-point increase in market interest rates could raise the percentage of households with a high net interest burden by 3.9 pp.

Banking System Resilience

The level of resilience of banks will depend on how they position themselves against these risks, including their provisioning and capital planning policies:

  • A prudent provisioning and capital planning policy that earmarks part of higher profits to bolster banks’ resilience would be beneficial

European Financial System

A smoother-functioning euro area with improved governance would make the European financial system less vulnerable:

  • The creation of a fully mutualised European deposit insurance scheme would boost both public and market confidence, contribute to greater risk-sharing in the euro area, and help reduce potential fragmentation episodes

Regulatory Challenges

An in-depth analysis is needed from a regulatory and supervisory standpoint to understand recent banking turmoil:

  • An assessment of the reasons for recent events in the United States has been published by the Federal Reserve System. Similar analyses are underway by the Financial Stability Committee and the Basel Committee on Banking Supervision.
  • Regulatory reforms such as Basel III must be transposed into law consistently so as to remedy outstanding shortcomings

Structural Challenges

The short and medium-term challenges posed by recent crises do not detract from the pressing need to tackle the banking sector’s structural challenges, including:

  • Climate-related risk management
  • Digitalisation
  • Growing competition from tech firms