ECB Report: 'Default Risk Has Increased Sharply in Greece'

Euro area systemic stress has remained low over the past six months, but the risk for a Greek default has increased sharply, according to the latest Financial Stability Review of the European Central Bank (ECB), which was released today.
Greek Deposits Outflow (review excerpt)
Althought prevailing financial market conditions clearly provide support for debt servicing capacity, at the same time, fiscal positions remain precarious in some countries. Sovereign risks emanating from Greece, in particular, have increased sharply owing to heightened political uncertainty over the past six months, while the banking sector in Greece has witnessed substantial deposit outflows, a loss of access to the wholesale funding market and deteriorating asset quality. Financial market reactions to the developments in Greece have been muted to date, but in the absence of a quick agreement on structural implementation needs, the risk of an upward adjustment of the risk premia demanded on vulnerable euro area sovereigns could materialise.
Default risk expectations have increased sharply in Greece (review excerpt)
“Greek Sovereign stress conditions have remained relatively benign against the background of the expanded asset purchase programme, with the composite indicator of systemic stress in sovereign bond markets still considerably below the levels seen at the height of the euro area sovereign debt crisis in 2011-12. The aggregate indicator, however, conceals substantial divergence in sovereign stress across countries. In particular, default risk expectations have increased sharply in Greece amid heightened political uncertainty.”
EU real estate rebounds but not in Greece (review excerpt)
“Indeed, country-level data indicate a strong rebound in residential and prime commercial property price growth in a number of countries, notably Ireland, the Netherlands and Spain (see Chart 1.32). By contrast, property prices continued to drop in countries such as Cyprus, Greece and Slovenia, in particular in the residential segment.”
Extreme Volatility in Greek markets; Contagion Minimised (review excerpt)
“Developments in Greece contrasted with broader euro area trends as yields increased and spreads vis-à-vis Germany widened. The lengthy and uncertain process of negotiations between the newly formed Greek government and its creditors contributed to bouts of extreme volatility in Greek markets. Contagion from Greece to other euro area markets was limited; indeed it triggered only minor volatility in sovereign yields and also in the credit default swap levels of Portugal, Italy and Spain. While there were short-lived intermittent rises in the correlation between sovereign yields for these countries and those of Greece, a broad-based rally in the context of positive sentiment related to the PSPP saw spreads of Irish, Italian, Portuguese and Spanish ten-year bonds vis-à-vis the Bund fall to fresh lows for the period following the onset of the sovereign debt crisis. Funding difficulties in Greece had no negative repercussions in other vulnerable countries where average deposit growth turned positive in early 2015, reaching 1.9% in February.”
No interim financing for Greece outside ECB legal frame work
Ewald Nowotny, an ECB governing council member and Austria’s central bank governor, said that the European Central Bank can’t provide interim funding to Greece under current rules.
“I know that there have been some ideas floating around that we [the ECB] might give some interim financing just like that. I don’t see any legal possibility for that,” Ewald Nowotny, told CNBC television in an interview broadcast Thursday.

Financial Stability Review Summary

• Euro area systemic stress remained low in past six months amid improving, but still subdued, economic growth
• Financial markets show continued asset price rises and bouts of volatility, but without generalised overvaluations
• Challenging operating environment for euro area banks and insurers, while rapid growth of shadow banking sector continues

Euro area systemic stress has remained low over the past six months, according to the latest Financial Stability Review of the European Central Bank (ECB), which was released today. This also reflects ECB action that calmed fears of a too prolonged period of low inflation threatening to harm both price and financial stability.
Despite a generally positive financial market sentiment, there have been repeated moments of tension in global financial markets. Large banks have become less confident about their ability to make markets during periods of stress.
Set against increasing financial risk-taking, economic risk-taking in the euro area is still lagging – something that is particularly visible in the contrast between appreciating financial asset prices and a low level of real investment. While the economic recovery in the euro area has been gaining momentum, it remains weak by international standards. At the same time, credit to the real economy is recovering, benefitting from ECB monetary policy action. Despite these signs of improving economic conditions, the risk of continuing low nominal growth remains a challenge to financial stability in the euro area. Should country, sector and institution-specific challenges arise, this would call for macroprudential policy measures, as monetary policy remains focused on price stability.
Financial system vulnerabilities continue to stem not only from the financial markets, but also from financial institutions, ranging from banks to insurers and – increasingly – the shadow banking sector. Bank profitability remains weak and the return on equity remains below the cost of capital for many banks. Despite the solid profitability reported so far, euro area insurers are facing growing challenges as the low-yield environment is testing their traditional reliance on fixed income assets as a means of generating portfolio returns. The shadow banking sector continues to grow robustly, increasing the potential for systemic risks. Finally, highly indebted sovereigns remain vulnerable to both economic and financial shocks.
The ECB has singled out four risks to financial stability over the next year and a half.

• Abrupt reversal of compressed global risk premia amplified by low secondary market liquidity
  Weak profitability prospects for banks and insurers in a low nominal growth environment, amid slow progress in resolving problem assets
• Rise of debt sustainability concerns in the sovereign and corporate sectors amid low nominal growth
• Prospective stress and contagion effects in a rapidly growing shadow banking sector
• The review also contains three special feature articles. They assess cross-border spillovers from macroprudential policies, examine the main drivers of euro area bank profitability over the past years as well as non-performing exposures in the banking system and their prospective resolution.

Read the full review below: