Global risk of shocks is unprecedentedly high, warns ECB

The European Central Bank (ECB) has warned that the global threat of shocks to the economy, financial markets and banks is at an unprecedentedly high level.

“Global uncertainties have surged to exceptional levels, creating an environment of heightened fragility, where risks once considered remote are becoming more likely,” the ECB said in its supervisory priorities for the next three years.

The ECB said the risks came from “geopolitical tensions and shifting trade policies, climate and nature-related crises, demographic change and technological disruptions”, with these factors exacerbating structural vulnerabilities.

“Uncertainty is elevated. This combination of factors heightens the risk of sudden and severe disruptions with far-reaching consequences for economies, financial markets and banks alike. It echoes the call to banks over the past years to remain vigilant and to avoid complacency,” the report said.

The ECB noted that weaker than expected growth, higher defence spending and challenges like ageing populations, climate change and digitalisation could undermine sovereign debt sustainability.

With that in mind, the ECB said it planned to give increasing supervisory attention to selected areas, including encouraging banks to prevent the accumulation of new non-performing loans and to implement new capital requirement frameworks.

The ECB also said banks needed to further strengthen their management of climate and nature-related risks given the growing frequency of natural disasters and slow progress towards the net-zero goals.

“Climate risk is a permanent shock heading in one direction only, with serious long-term effects on house prices and other asset values,” it said.

The ECB said the growing insurance protection gap, with only around 25% of natural hazard losses insured, poses further risks to economic growth and to banks’ balance sheets, along with the risk of a disorderly transition.

While many banks have made progress to address climate risks, the ECB said there were still weaknesses at some banks which supervisors would follow up on.

“Going forward, supervisors will continue to monitor banks’ progress and remediation of shortcomings, while focusing targeted supervisory exercises on prudential transition planning requirements and persisting challenges to banks’ compliance,” it said.