Luxembourg: Financial Sector Assessment Program-Financial System Stability Assessment

This paper presents Luxembourg’s Financial System Stability Assessment report. The assessment of Luxembourg’s large, interconnected, and complex financial system took place against heightened economic, financial, and geopolitical uncertainty. The authorities have made commendable progress in following up on recommendations from the 2017 Financial Sector Assessment Program (FSAP). The stress tests found the financial system resilient to severe shocks, while identifying a few potentially weak entities. Higher interest rates have benefited banks, despite increasing loan losses among households and real estate companies. Under plausible adverse scenarios, the system can handle significant liquidity shocks, with minimal second-round price impacts. However, the growing connections of other financial intermediaries with investment funds and related data gaps call for greater monitoring. The FSAP recommends strengthening the macroprudential policy framework by reducing the risks of inaction bias and expanding the use of policy measures against rising real-estate vulnerabilities. Banks should use the capital headroom to implement a sectoral systemic risk buffer and prepare for tightened borrower-based measures when the financial cycle turns positive.