Systemic stress in the European financial system is down to pre-crisis levels, but the weak economic recovery remains an ongoing risk that could threaten financial stability, says the European Central Bank (ECB).

In a new report, the ECB says that systemic stress among euro area banks and sovereigns has declined further to levels not seen since before the onset of the global financial crisis in 2007. The region’s banks have also made progress on repairing their balance sheets in the wake of the ECB stress tests, it notes.

However, the central bank also cautions that the economic recovery remains weak, fragile and uneven. And, it says that weakness “could potentially reinforce financial stability risks, against a backdrop of a global search for yield”.

It sees three key risks to financial stability over the next 18 months that could reinforce each other, if they are triggered, including: persistently sluggish bank profitability in a weak, fragile and uneven macroeconomic recovery; the re-emergence of debt sustainability concerns amid low growth and wavering determination for fiscal and structural reform; and, the prospect of an abrupt reversal of the global search for yield, amplified by pockets of illiquidity.

“This calls for continued efforts to improve the oversight of and the tools to deal with risks from shadow banking activities,” it says.