With the potential for higher energy prices to stoke inflation and hamper economic growth, the global financial system is facing large, growing risks, European regulators warn in their latest report on systemic stability.
The European Supervisory Authorities — which includes securities, banking, insurance and pension regulators — flagged the economic and financial fallout from the onset of military conflict in the Middle East as an emerging threat to financial stability.
The conflict gives rise to an array of risks including market, liquidity, asset and infrastructure risks, the paper said, due to higher energy prices, which may boost inflation and undermine economic growth — effects that may spill over to financial markets that already face valuation and liquidity strains.
Economically-damaging military conflicts “can exacerbate market vulnerabilities, triggering volatility and revaluations,” it noted.
Additionally, the prospect of higher inflation raises the risk of higher interest rates, boosting funding and asset quality risks, the report said, adding that the conflict and the risk of cyberattacks “could generate shocks and disruptions to critical infrastructures.”
Given these growing risks, the regulators called on industry firms and supervisors “to maintain a high level of readiness” to deal with potential financial fallout.
Specifically, they stressed the need for ongoing risk assessments, close monitoring of the impact of higher energy prices, incorporating the shifting geopolitical considerations into risk management activities and prudently handling sovereign exposures.
Alongside the latest geopolitical conflicts, the report also highlighted vulnerabilities in private financial markets, “driven by limited data, low transparency, prolonged growth and complex, opaque interconnections with the broader financial system.”
Strains in private markets could also spill over to the broader financial system in unexpected ways, it noted, adding that the recent turmoil in certain U.S. private credit funds highlights “potential vulnerabilities related to changes in investor sentiment.”