Financial market risks stemming from emerging markets, especially China, are rising, while the limited direct exposure of the euro area banks to these markets reduces the impact, the European Central Bank said in a report released Wednesday.
“Occasional bouts of financial market volatility suggest that vulnerabilities stemming from emerging markets are increasing. Of particular concern is the outlook for China, given its growing role in the world economy,” the ECB said in its latest bi-annual Financial Stability Review.
“Partly as a result of increased vulnerabilities stemming from emerging markets, the risk of an abrupt reversal of global risk premia is increasing,” the ECB report said.
Earlier this year, the Eurozone financial system was able to withstand the spillover effect of the political and financial crisis in Greece as well as the impact of the stock market rout in China, the report noted.
The report also pointed out that financial stability concerns have been increasing generally across a number of emerging market economies.
“Highly indebted foreign-currency borrowers may be vulnerable to a prospective normalization of financial conditions in the United States and other advanced economies,” the ECB cautioned.
The ECB also urged banks to further adjust their business models to cope with persistently weak economic conditions amid an environment of historically low interest rates.
The report also drew attention to the rapid growth and the interconnectedness of the shadow banking sector, saying that vulnerabilities are likely to be accumulating below the surface.
“A more widespread use of synthetic leverage and the increasing prevalence of demandable equity imply that the potential for a systemic impact is increasing, should the investment fund industry come under stress,” the ECB warned.
The bank also said that misaligned asset prices were a key vulnerability as they could potentially lead to sharp adjustments of risk premia.
Further, the bank said there was concern that low market liquidity may amplify potential corrections in asset prices though risk premia remain compressed. The bank also stressed on the need for close monitoring of stronger co-movement across financial asset classes as it may have repercussions on financial stability.
The material has been provided by InstaForex Company – www.instaforex.com