EU flags waving in front of European Parliament building. Brussels, Belgium

The threat to financial stability posed by the pandemic may have faded, but other risks are gaining strength, says the European Central Bank (ECB).

In a new report, the central bank said that the economic recovery has curbed short-term stability risks posed by the pandemic.

However, financial markets still face a variety of other emerging risks that include surging inflation, overheated asset valuations, and elevated private and public debt levels.

“Risks of high rates of corporate defaults and bank losses are now significantly lower than six months ago. But risks from the pandemic have not disappeared entirely,” said Luis de Guindos, vice president of the ECB.

While corporate profits have recovered alongside the economy, and insolvencies remain low, financial distress could still rise — particularly in sectors that were hardest-hit by the pandemic, the ECB suggested.

Additionally, the recovery faces possible headwinds in the form of rising inflation and global supply chain disruptions.

“The risk of price corrections has increased in some real estate and financial markets,” the report warned.

In particular, residential real estate markets have grown increasingly vulnerable, particularly in countries where markets were already hot heading into the pandemic.

“Riskier segments of global financial markets have experienced increasing investor demand, with interest widening in novel asset classes such as crypto-assets,” the ECB noted.

At the same time, institutional investors — including investment funds, insurers and pension funds —  have increased their exposure to lower-rated corporate debt, and “could face substantial credit losses if conditions in the corporate sector were to worsen.”

Investment funds also remain highly exposed to liquidity risk, the central bank said.