According to the financial stability review published by the ECB on 19 December, the sovereign risk crisis and its interplay with the banking sector worsened in an environment of weakening macroeconomic growth prospects during the second half of 2011. Among the risks identified, contagion effects in larger euro area sovereigns gathered strength amid rising headwinds from the interplay between the vulnerability of public finances and the financial sector.

The European Central Bank (ECB) published its financial stability review in which highlights that risks to euro area financial stability increased considerably in the second half of 2011. According to the report, a combination of weakening macroeconomic growth prospects and the unprecedented loss of confidence in sovereign signatures were key factors, crystallising in downgrades, both within and outside the euro area, by major credit rating agencies.

The report also underlines that financial stability in the euro area has faced strong headwinds. In particular, the risks which are key at the present are contagion and negative feedback between the vulnerability of public finances, the financial sector and economic growth; funding strains in the euro area banking sector; the weakening macroeconomic activity, credit risks for banks and second-round effects through a reduced credit availability in the economy; and imbalances of key global economies and the risk of a sharp global economic slowdown.

ECB also published in the review the measures announced or adopted by the European Council and Heads of State or Government which contain several basic elements that are key for the restoration of financial stability in the euro area. Among them, the package of measures to restore confidence and address the current tensions in financial markets agreed by the European Council and euro area Heads of State or Government on 9 December. A swift and effective implementation of all key elements – a new fiscal compact and the strengthening of stabilisation tools for the euro area, including a more effective European Financial Stability Facility (EFSF), the bringing-forward of the implementation of the European Stability Mechanism (ESM) and a solution for the unique challenges faced in Greece.