a man on a precipice

Rising debt levels and buoyant equities markets amid an uncertain economic recovery point to rising vulnerabilities for the financial system, says a new report.

A trio of European regulators — including the European Securities and Markets Authority, European Banking Authority, and European Insurance and Occupational Pensions Authority — issued a report that warned of accumulating financial sector risks.

“Vulnerabilities in the financial sector are increasing, not least because of side effects of the crisis measures, such as increasing debt levels and upward pressure on asset prices,” it said.

The report said the sustainability of current market valuations remains a concern, and that industry firms should be prepared for a possible decline in asset quality in the financial sector, despite the ongoing economic recovery.

Additionally, rising inflation expectations, increased investor risk appetites and financial interconnectedness “might put additional pressure on the financial system,” it said.

The emergence of events such as the collapse of Archegos and Greensill, the arrival of so-called meme stocks, and the ongoing development of cryptoassets “raise questions about increased risk-taking behaviour and possible market exuberance,” it said.

These risks are also accompanied by intensified cyber-risk.

“The financial sector has been hit by cyberattacks more often than other sectors, while, across the digital economy, cybercriminals are developing new techniques to exploit vulnerabilities,” it said.

“Financial institutions will have to rapidly adapt their technical infrastructure in response to the pandemic, and the crisis has acted as a catalyst for digital transformation more generally.”