EXECUTIVE SUMMARY AND POLICY ACTIONS

Valuation risk and the potential for sudden risk premia reversals remained a major concern in the second half of 2017. During that time, equity prices continued to increase amid volatility at historically low levels. While low volatility reflected to some extent expectations of continued monetary policy support, the absence of market reaction to recent events possibly increased investor complacency and the probability of sudden risk repricing. This might have contributed to the return of global equity market volatility in February 2018 and associated equity price falls, with the VIX increasing above 40%, the highest in several years. Despite the recent spike in volatility, the risks related to valuations and repricing of risk premia remain and could, among other things, adversely impact profitability and asset quality across sectors. Asset quality in the banking sector has recently improved and volumes of non-performing loans (NPLs) disposals are increasing. Yet amounts of NPLs in banks’ balance sheets are still high and require further action by banks and supervisors.

Uncertainties around the terms of the UK’s withdrawal from the EU still have the potential to expose the EU27 and the UK to economic and financial instability and to weaken market confidence, in particular if negotiations end in a disorderly fashion. The absence of a conclusive agreement on the withdrawal terms could affect the legal framework for financial services and hence the continuity of financial contracts as well as imply challenges for the operations of firms.