European Central Bank Publishes June 2009 Financial Stability Review

Yesterday, the European Central Bank (ECB) published the June 2009 edition of the ECB Financial Stability Review.  The objective of the ECB’s Financial Stability Review, which is published twice a year (in June and December), is to "[r]eview the main sources of risk to, and vulnerability for, financial system stability and to provide a comprehensive assessment of the capacity of the euro area financial system to absorb adverse disturbances."  By providing an overview of sources of risk and vulnerability, the review "[s]eeks to play a role in preventing financial crises."

The sources of risk and vulnerabilities identified in the Financial Stability Review, as summarized by ECB Vice-President Lucas Papademos, include:

1) The "crystal[ization]" of the downside risks identified in the December 2008 Financial Stability Review, including:

• Further deterioration in the U.S. and the Euro-area housing markets;
• Deeper and more prolonged slowdown in both the global and the Euro-area economy;
• More pronounced de-leveraging by banks, due to persistently high funding costs and concerns about the adequacy of capital buffers; and 
• A surge in financial market volatility caused by a further unwinding of positions by hedge funds.

2) The concern that the following additional risks could materialize if the global economic downturn proves to be deeper and more prolonged than currently expected:

• A further erosion of capital bases and the risk of a renewed loss of confidence in the financial condition of large and complex banking groups;
• Significant balance sheet strains emerging among insurers;
• More widespread asset price declines coupled with high volatility;
• U.S. house prices falling further than currently expected;
• More severe economic downturn in the Euro area than currently projected; and
• An intensification of the stresses already endured by central and eastern European countries.