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ECB warns European banks to beware of this risk of instability

European banks again alerted by the ECB.
Although the risk of financial instability has been averted, the future scenario suggests some threats of shock for credit institutions.
Specifically, the Eurotower has once again targeted the commercial real estate market of the Eurozone which is currently in difficulty, but for which a crisis is estimated for years to come.
This prospect leaves bank loan portfolios, investment funds and insurers exposed, according to ECB experts.
Economic weakness and high interest rates have depressed real estate prices over the last year and caused real estate companies to reduce their profitability, putting the entire business model of the commercial real estate market to the test.
A large shock in this sector would drag various sectors into crisis, with repercussions also on bank balance sheets according to the ECB.
read also These risks threaten the banks, says Lagarde Why the ECB has issued a real estate alert to European banks The exposure of European banks to commercial real estate could erode financial stability if the economy is hit by a bigger shock, according to the European Central Bank.
Commercial real estate markets “have the potential to significantly amplify an adverse scenario, increasing the likelihood of systemically important losses occurring in the banking system,” the ECB warned in an excerpt of the financial stability document to be published tomorrow.
The critical point is that commercial real estate transactions declined 47% in the first half of 2023, compared to the same period a year earlier.
read also Banks, what changes with the end of rate rises This makes it difficult to say how far prices have fallen, but the Eurozone's largest listed property owners are trading at a discount of more than 30% to asset value net, the largest discount since 2008 according to the ECB.
According to a sample of bank loans to real estate companies, the recent increase in financing costs could cause the share of loans given to loss-making companies to double to 26%.
If tighter financing conditions persisted for two years, as markets expect, and businesses were forced to roll over all maturing loans, this rate would rise to 30%.
The European Central Bank's alarm was therefore justified as follows: "there are substantial vulnerabilities in this loan portfolio, especially considering that both higher financing costs and reduced profitability are expected to persist for a number of years" .
Residential mortgages represent approximately 30% of bank loan portfolios, while commercial real estate loans account for approximately 10%.
The percentages alone are not alarming.
However, while the relatively small size of banks' commercial real estate portfolios means that they alone are unlikely to lead to a systemic crisis, deeper sector turbulence would affect other CRE exposures, such as those of investment funds and insurers.
The sum of all these adverse factors must increase prudence in European banks according to the ECB, to avoid financial shocks in the near future.

Author: Hermes A.I.

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