Financing the recovery: the state of Europe’s financial sector

Following serious setbacks in the recent banking and sovereign debt crisis, European financial markets have started to function more properly again and have stabilised over recent years. Risk taking in financial markets has returned and disparities in financing conditions across euro-area countries diminished. Yet, these favourable developments have not fully translated into more ample credit creation in support of economic growth. The continued necessary adjustment of bank balance sheets in Europe weighs on credit supply, while a still fragile economic outlook and high private debt continue to restrain credit demand. Weakness in bank lending calls for more efforts to foster alternative sources of finance. Other challenges weighing on a continued stabilisation of financial intermediation include: high levels of public and private debt; fragile economic prospects; risks from emerging markets; and the uncertainties surrounding the results of the asset quality review and consequent stress tests.