The European Central Bank just outlined the four biggest risks to financial stability over the next two years, which are partly triggered by heightened political uncertainty.
In a statement titled “Global risk repricing endangers financial stability,” the Financial Stability Review from the ECB outlined the following four “systemic risks” to financial stability.
- Financial contagion stemming from political uncertainty — “Global risk repricing leading to financial contagion, triggered by heightened political uncertainty in advanced economies and continued fragilities in emerging markets.”
- A vicious circle between banks not making much money and not being able to grow — “Adverse feedback loop between weak bank profitability and low nominal growth, amid challenges in addressing high levels of non-performing loans in some countries,” says the ECB.
- Debt sustainability — The ECB said that “re-emerging sovereign and non-financial private sector debt sustainability concerns in a low nominal growth environment, if political uncertainty leads to stalling reforms at the national and European levels.”
- Investment funds — These funds, which are a supply of capital belonging to a group of investors that are used to buy securities such as stocks, are seen as risk factor. “Prospective stress in the investment fund sector amplifying liquidity risks and spillovers to the broader financial system,” says the ECB.
In other words, the ECB see heightened political uncertainty, most likely borne out of the Brexit vote, a range of elections in Europe, and the Italian referendum on constitutional reform, hurting markets and therefore causing big risks spreading across to the economy.
ECB said in a statement (emphasis ours):
“Risks extend also to the real economy. In particular, concerns about debt sustainability might re-emerge despite relatively benign financial market conditions. Higher political uncertainty may lead to more domestically focused, growth-hindering policy agendas. This, in turn, could delay much needed fiscal and structural reforms and could in a worst-case scenario reignite pressures on more vulnerable sovereigns.”
The ECB’s assessment echoes the sentiment of some investors in the market.
Earlier in November, Steve Eisman, an investor who made a fortune by successfully predicting the 2007-2008 financial crash, said European banks cause him concern.
“Europe is screwed. You guys are still screwed,” he said. “In the Italian system, the banks say they are worth 45-50 cents in the dollar. But the bid price is 20 cents. If they were to mark them down, they would be insolvent.”
His concern is that European banks — particularly Italy’s — hold bad “non-performing loans” that are improperly valued, posing a very serious risk to the banks’ solvency.
In short: If many European banks admitted the true value of their loans, they’d go under, Eisman believes — potentially sparking a new financial crisis.
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