ECB supervisor warns higher rates and uncertainty test euro zone banks’ resilience

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ECB warns euro bank resilience

Highlights

ECB Supervisory Board member Patrick Montagner highlights that higher rates are squeezing euro zone banks' funding costs and could pressure lending demand, especially in residential mortgages.
Montagner states euro area banks' sovereign bond holdings are about 9% of assets and risks remain limited, though contagion could arise if combined shocks materialize.
ECB emphasizes banks' improved capital quality since 2008 but urges caution on relaxing capital requirements and regulatory framework, given rising uncertainty and AI-driven supervisory challenges.

Supervisory view on rates, spreads and balance-sheet risks

As reported by European Central Bank, citing the ECB’s Supervisory Arm, Supervisory Board member Patrick Montagner says banking supervision is assessing the current environment through the lens of resilience, with uncertainty building for more than two years across rates, energy-linked geopolitical risks and private asset markets inflated by the era of near-zero borrowing costs.

Montagner says higher rates affect both sides of banks’ balance sheets. Funding costs are rising through customer deposits and market borrowing, while margins may come under pressure if banks cannot pass those costs on through lending rates. Even if they do reprice loans, he says demand could weaken, particularly in rate-sensitive segments such as residential mortgages.

He also points to banks’ sovereign bond holdings as an area to monitor, although he describes the risk as limited. Banks can hedge interest rate exposure, the effect depends on asset maturities, and sovereign bonds account for about 9% of euro area banks’ total assets, while lenders are not required to sell them.

On widening spreads, Montagner says the ECB does not currently see a rise in risk for the banks it supervises. He says the key issue is not a simple comparison with past spread levels, but how multiple risks could combine and create stress that then spreads through contagion channels across the financial system.

Capital strength, competitiveness and regulatory debate

Montagner says European banks are in a much stronger position than in 2008, with significantly better quality capital and greater shock-absorption capacity. He adds that lenders have also benefited from solid profitability over the past two to three years, as positive rates have restored their role as financial intermediaries.

He draws a similar contrast with 2012, when the European banking sector was under severe strain and banks had largely stopped lending to one another. While the ECB remains cautious, he says the starting point is now far more resilient, making the preservation of that resilience the central supervisory priority.

On competitiveness, Montagner says the ECB has backed efforts to streamline the regulatory framework, arguing that overlapping rules from different authorities have added complexity and sometimes contradictory effects for capital management. Still, he says the ECB supports keeping a Single Rulebook across the bloc, with only targeted adjustments, because depositor confidence should not depend on the type of bank holding their money.

He also urges caution on any easing of capital requirements at a time when uncertainty is rising. The same logic applies, he says, to the debate over the Basel output floor, whose role should be maintained even if its calibration is reassessed, as proposed by the European Commission.

Montagner adds that artificial intelligence is introducing another layer of uncertainty for supervision, with potential implications for credit decisions, market operations and risk hedging. He says the main concern is that several uncertainties could converge and act as the trigger for a broader economic shock.

Our earlier report on proposed UK gilt repo market reforms highlighted how authorities are looking to bolster resilience in short-term funding markets as gilt volatility persists. It noted industry warnings that measures such as broader central clearing and minimum haircuts could have unintended consequences, including pushing hedge funds toward more reliance on daily repo and increasing vulnerability if funding conditions tighten.

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