FRANKFURT (Reuters) – The European Union’s financial system may not cope on its own with a looming wave of credit rating downgrades caused by the coronavirus pandemic, which may disrupt funding markets, the bloc’s financial stability watchdog said on Thursday.
The European Systemic Risk Board (ESRB) said the European market for high-yield bonds is too small to absorb a raft of downgrades to “junk” comparable to the one in the last financial crisis and warned about the knock-on for banks, insurers and companies.
The warning may be paving the ground for the European Central Bank, which hosts and heads the ESRB, to add speculative-rated bonds to its 1.1 trillion euro (973.37 billion pounds)shopping list – a prospect its staff are already studying.
“There may be limits to the extent to which private sector actions – even with coordinated supervisory interventions – can maintain market liquidity and the smooth functioning of markets,” the ESRB said in a note.
“Central banks across Europe have stressed their determination to take additional steps, if and when necessary, to avoid a procyclical tightening of financing conditions.”
Assuming 18% of investment-grade companies are downgraded, the euro zone’s high-yield market would need to absorb 132 billion euros worth of new debt, equal to 50% of its current size, the ESRB said, adding this was “unrealistic”.
Chiared by ECB President Chistine Lagarde, the ESRB includes the governors of the euro zone’s 19 national central banks and representatives of the EU’s other financial watchdogs.
Reporting By Francesco Canepa; Editing by Andrew Cawthorne