Euro area financial stability situation remains positive, supported by strong economic growth, but the threat of an abrupt market correction due to global risks remain, the European Central Bank said in a report released Wednesday.
"Improved economic conditions underpin the assessment that there is no generalized overvaluation in euro area financial markets," the ECB's latest Financial Stability Review said.
"Nevertheless, global risks in particular may trigger financial asset market corrections with negative repercussions on financial stability."
The FSR identified four main risks to euro area financial stability over the next two years.
These include an abrupt and sizeable repricing of risk premia in global financial markets, the continued weak profitability prospects for the banking sector, a potential re-emergence of public and private sector debt sustainability concerns and liquidity risks in the non-bank financial sector.
The report said that improved growth prospects in the euro area and other advanced economies could mitigate the likelihood of these risks materializing and reduce the probable systemic impact should any of them materialize.
"Continued risk premia compression and signs of increased risk-taking behavior in financial markets are sources of concern as they may sow the seeds for large asset price corrections in the future," the bank warned.
The ECB also expressed worry that financial markets may not be fully alert to the possibility that the current favorable market sentiment can change quickly.
Regarding euro area banks, the ECB said they are considered riskier than their global peers. Their profitability outlook remains clouded by the structural challenges such as low valuations and higher perceived risk.
Further, there is slow progress made in tackling high non-performing loan ratios in certain jurisdictions, the report added.
The FSR also said that residential property price valuations appear to be broadly in line with fundamentals, while prime commercial property valuations have departed further away from long-term averages.
"Favorable financing conditions coupled with an improved economic outlook should underpin the sustainability of the recovery, but buoyant developments in some countries and asset classes may warrant closer monitoring inthe current low-yield environment," the report said.
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