FRANKFURT – The European Union's three financial watchdogs see little chance of contagion from financially troubled Cyprus after completing their joint review of risks facing European financial markets.
The three supervisory authorities, covering banking, insurance and markets, have been closely monitoring developments in the debt-laden country and expect the winding down of Laiki Bank and the restructuring of the Bank of Cyprus to lead to losses throughout the Cypriot financial sector, the authorities said in joint statement on Friday.
"The risks of direct international contagion seem to be limited," the authorities said, adding that market conditions and deposits in Cyprus have remained relatively stable.
It was the first time the three watchdogs have made public their joint review of financial sector vulnerabilities.
The European Banking Authority (EBA), the European Securities and Markets Authority (ESMA) and the European Insurance and Occupational Pensions Authority (EIOPA), plan to publish future assessments twice a year.
"This cross-sectoral work provides EU policy-makers and regulators with an overall view of the risks they face and moves us away from a narrow sectoral approach, and the inherent risk of failing to see the big picture," said EIOPA head Gabriel Bernardino, who is the current chairman of the joint committee.
The watchdogs said near-term risks to the financial sector have abated since September 2012 but banks remain vulnerable to a sudden switch in market sentiment.
Financial markets remain uncertain about how banks are valuing the assets on their balance sheets and disclosing the risks they face, the authorities said.
"This uncertainty affects both banking book and trading book assets, and ultimately the valuation of capital," they said.
"Supervisors are strongly encouraged to monitor and review the quality of banks' assets and the practices of banks to measure the quality of their assets," the authorities said, adding that watchdogs should set "appropriate incentives" to correct distortions in valuation.
The authorities pointed out that international regulators were working on ways to redesign interest rate benchmarks, following misconduct at banks in the setting of the London Inter-Bank Offered Rate (Libor) and its European equivalent, Euribor.
"While more work needs to be done in designing sustainable resilient solutions for setting of financial benchmarks, continuity of existing benchmarks also needs to be maintained, e.g. by mitigating the risk of disruptive withdrawals from existing rate-setting panels."
The Libor/Euribor rates, compiled from estimates by large banks of how much they believe they have to pay to borrow from each other, are used to determine interest rates on trillions of dollars worth of contracts around the world.
Swiss bank UBS, Rabobank and Citi are among several lenders that have dropped out of the panel setting the Euribor rate.
The watchdogs also cited banks' increased reliance on and reuse of collateral as a potential concern because it was bolstering financial sector inter-connectedness and contagion risks, something regulators needed to monitor.
The weak economy and low interest rates were also taking their toll, hurting profitability at banks and insurers and promoting a potentially unhealthy search for yield by institutional investors, the authorities said.
The watchdog's joint review of vulnerabilities feeds into the deliberations of the European Systemic Risk Board, which involves the European Central Bank and aims to avoid macro economic threats like those that caused the 2007-2009 financial crisis.
(The joint committee's report can be found at: https://eiopa.europa.eu/joint-committee/index.html)
(Editing by Mark Potter)