“Notwithstanding the improvement in euro area [banks’] earnings in 2009, the outlook for euro area banking system stability is clouded by significant risks,” the ECB said in its 2009 annual report.
Rising loan losses were likely to keep bank profits under pressure for some time to come, while net interest income – a major source of bank revenue – could be dampened if the yield curve flattens, the central bank warned.
“There are reasons to be cautious about the durability of the recent recovery in banks’ profitability, since the extraordinarily supportive environment for investment banking activities is unlikely to persist as market conditions begin to normalise,” it added.
Further risks stemmed from the unwinding of government support, which totalled around €2.4 trillion (£2.1 trillion) or 26 per cent of euro area GDP, given to the banking sector during the financial crisis.
Too early an exit might leave some banks vulnerable to an external shock if they have not regained sufficient financial strength.
However, leaving the support in place too long might distort competition between banks or even encourage some banks to again take on excessive financial risks, the ECB said.