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ECB Says Financial Risks Rising With Corporate Debt Vulnerable

ECB Says Financial Risks Rising With Corporate Debt Vulnerable

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Risks to the euro zone’s public and private finances have risen in the past six months, with indebted companies especially exposed, according to the European Central Bank.

In its semi-annual Financial Stability Review, the ECB said downside economic risks remain “prominent” and market volatility at the start of the year highlighted how a sudden rise in funding costs could hurt debt-laden companies and governments.

There was also a gloomy prognosis for the banking industry with a warning that profitability, already weaker than that of international peers, will remain below levels demanded by investors.

Still, the ECB didn’t follow the argument of many lenders that its negative interest rates are to blame. Instead it said fault lies with banks themselves, saying the main issues are high cost structures, limited revenue diversification and “legacy assets” -- essentially non-performing loans.

On the positive side, it said capital adequacy is strong, implying “widespread resilience to plausible adverse scenarios.”

Financial Stability Review

ECB sees four key areas of risk ahead...
  • Disorderly increase in risk premiums: global corporate bond spreads are at pre-crisis lows, and U.S. equity valuations are high
  • Debt sustainability concerns: government debt is high, and the amount of lower-rated corporate debt has doubled over the past five years
  • Hampered bank intermediation capacity: a crowded euro-area banking sector is confronted with high operating costs
  • Increased risk-taking in the non-bank financial sector: the search for yield, liquidity risk and leverage could amplify the wider financial cycle

The Frankfurt-based central bank said it’s concerned over debt sustainability for some governments, which could face difficulty refinancing if investors reassess the risk of sovereign bonds.

A number of euro-zone countries have struggled to get their borrowing under control, while six years of economic expansion buoyed by ultra-low interest rates have seen some companies pile up debts. Now the region is struggling with slower growth and subdued confidence amid potential shocks such as trade tariffs and a no-deal Brexit -- events which would probably cause funding costs in the market to rise.

“Repricing risks appear particularly high in riskier segments of the corporate sector,” the ECB said. “The global leveraged loan sector, which has grown significantly in recent years, is susceptible to weaker corporate earnings.”

To contact the reporter on this story: Paul Gordon in Frankfurt at pgordon6@bloomberg.net

To contact the editors responsible for this story: Fergal O'Brien at fobrien@bloomberg.net, Catherine Bosley

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