Mirroring the magnitude of the crisis, vulnerabilities and sources of risk have sprung widely from the euro area macro-financial environment. While remaining uneven across both economic sectors and countries, the breadth of vulnerabilities continues to relate predominantly to the unusual amount of balance sheet adjustment necessary after the widespread credit expansion that presaged the global financial crisis. This applies most acutely to the government sector – with worsening public finances a feature shared by virtually all advanced economies. The non-financial private sector also faces some challenges, notably from an ongoing macroeconomic slowdown, but with aggregate euro area balance sheet positions that make it relatively more robust to weather such forces. In parallel, financial markets exhibited heightened volatility and, on occasion, even extreme turbulences, with sharp adjustments characterising the latter half of 2011. In this environment, financial stability in the euro area has faced strong headwinds. In particular, four related and intertwined risks are key at present:
- Contagion and negative feedback between the vulnerability of public finances, the financial sector and economic growth
- Funding strains in the euro area banking sector
- Weakening macroeconomic activity, credit risks for banks and second-round effects through a reduced credit availability in the economy
- Imbalances of key global economies and the risk of a sharp global economic slowdown
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