In its recently released biannual stability assessment, the European Central Bank claimed that the biggest financial vulnerabilities the Eurozone is facing are a traditional banking sector with profitability problems together with an increasing shadow banking system. Those, together with other factors, have contributed to increasing credit and liquidity risks.
The UE's cumbersome regulatory mark, together with ultra-low cash rates, may be punishing the traditional financial sector, affecting their profitability, and opening the way to an alternative financial system. However, on a preliminary assessment, the ECB attributes this mainly to what they call "structural issues": Overcapacity, insufficient income diversification, bad competitive dynamics, and a poor cost-efficiency.
"Structural changes in the banking sector need to be part of the solution to the weak bank profitability problem," stated the ECB on its report.
The non-banking system (or shadow banking sector) is also discussed in the report, as it grew in the first half of this year. Countries like China are also facing this problem.
"The growth in the sector is reflected in the higher flow of market-based debt financing to euro area non-financial corporations (NFCs) relative to bank financing," says the report.
Despite helping to diversify the financial sector, reducing euro-area firms' exposure to funding shocks, among other advantages, its fragility supposes a source of systemic risk, adding to the vulnerability of the Eurozone financial system. Besides this, non-banks are also facing profitability challenges, which encourage them to acquire risky and less liquid bonds.
"Profitability challenges have encouraged non-banks to increase their exposure to riskier and less liquid securities," explains the Bank on its report, adding that this search for yield is also exposing the system to emerging markets economies, adding to the risk.
As if this were not enough, the non-banking sector doesn't face the same regulatory framework as the traditional banking system, leaving the doors wide-open to an already increasing systemic risk.
As a solution, the bank proposes the EU members to develop macro prudential measures, like establishing liquidity requirements for insurers and setting restrictions on leverage. This approach is coherent with the consensus among post-2008 crisis policymakers regarding how to face the increase of systemic risks.
"Further progress is still needed to develop macro prudential tools for non-banks," added the report.
By 12:05 GMT the Euro went down against the US dollar by 0.18 percent, falling to the 1.1058 level. Conversely, it fell 0.24 percent against the Japanese Yen, at 119.94, while gaining 0.05 percent against the Swiss Franc, at 1.0975