ECB Warns Of Rising Soverign Risks From Greece

(RTTNews) - Further delay in reaching an agreement between Greece and its creditors could raise the yields on debt of other countries even though the sovereign-banking sector feedback mechanisms are less likely to cause much damage this time, the European Central Bank said in a report on Thursday.

"Sovereign risks emanating from Greece, in particular, have increased sharply owing to heightened political uncertainty over the past six months, while the banking sector in Greece has witnessed substantial deposit outflows, a loss of access to the wholesale funding market and deteriorating asset quality," the ECB said in its bi-annual Financial Stability Review.

"Financial market reactions to the developments in Greece have been muted to date, but in the absence of a quick agreement on structural implementation needs, the risk of an upward adjustment of the risk premia demanded on vulnerable euro area sovereigns could materialize."

Speaking on the sidelines of the release of the report, ECB Vice President Vitor Constancio stressed that there was no 'automatic' connection between a default of the Greek government and the solvency of Greek banks.

Constancio maintained that Greece will not leave euro even if it default on its debt repayments.

The ECB also warned of weak profitability outlook for banks and insurers in a low-interest rates environment.

The report said banks' profitability could benefit from the ECB's expanded asset purchase programme, which underpins nominal growth, improves asset valuations and effectively rules out debt deflation.

"These benefits notwithstanding, net interest margins are expected to remain under pressure as a result of the low interest rate environment and flattening yield curves," the ECB said.

"Bank profitability might therefore be squeezed further if banks cannot compensate for this by increasing loan volumes and/or reducing credit risk."

For insurers, prolonged period of low interest rates could dampen both investment income and the profitability of new policies sold, the ECB said.

"This is particularly relevant for those entities seeking sustained portfolio returns to match their liabilities, with limited scope for portfolio diversification," the report said.

"Such market conditions pose a significant challenge for some insurance companies' profitability in the medium term, with the potential to erode capital positions in the long run."

Further, the bank cautioned that benign financial market conditions may obscure the urgency of fiscal and structural reforms. The report also warned of a possible reassessment of sentiment towards euro area sovereigns, if crucial reforms are delayed.

"Such a reassessment would probably also pose debt sustainability concerns for non-financial firms," it added.

The ECB also expressed concern that shadow banking entities could be part of future systemic events, also on account of their increased size and remaining opaqueness.