Risks to euro zone financial stability have increased, ECB warns

ECB warned about four main sources of risk- market turmoil, weak profits, excessive debt, and a growing shadow banking sector

Risks to the euro zone's financial health have increased over the past six months, with a new bout of market turmoil and weak profits for banks and insurers emerging as the key sources of potential trouble, the European Central Bank said on Tuesday.

The ECB said in its semi-annual Financial Stability Review (FSR) that systemic stress had remained contained in the euro zone. But it warned about four main sources of risk for the next two years: market turmoil, weak profits in the financial sector, excessive debt, and a growing shadow banking sector.

"Compared with the November 2015 FSR, most risks have increased," the ECB said.

"At the same time, all risks are clearly intertwined and would, if they were to materialise, have the potential to be mutually reinforcing. Indeed, all risks could be aggravated by a materialisation of downside risks to economic growth."

It said financial conditions had become "more challenging" due to concerns about emerging markets, rising geopolitical risks and renewed bouts of market volatility, raising risks to the euro zone's moderate recovery.

The ECB cut its interest rates and boosted its money-printing programme to 1.74 trillion euros ($1.95 trillion) in March, but some economists expect it to ease its monetary policy again before the end of the year.

Among the risks facing the banking sector, the ECB emphasised the high level of bad loans in some countries and it called for lenders and authorities to do more to bring it down, including by making it easier to set up 'bad banks'.

"Banks should strengthen internal workout capabilities, while authorities should support the development of an efficient NPE (non-performing exposure) market as well as the carve-out of specific NPE portfolios and their transfer to special-purpose vehicles," the ECB said.

($1 = 0.8944 euros)