2023-12-21 13:13:45
For the first time since 2015, the stock of non-performing loans (NPLs) on the balance sheets of European banks is increasing, albeit at a moderate pace. However, according to Scope, the most likely scenario is only a gradual deterioration in bank asset quality as a result of higher interest rates and a modest economic recovery in most European countries.
But this will have only a marginal impact on the creditworthiness of European banks. An NPL shock is unlikely to materialize, according to Scope, who even points out that countries that have previously starred in high levels of problem loans, such as Italy and Greece, will perform better. However, if the economic slowdown is more pronounced, there could be a wider materialization of credit risk in the second half.
The rapid rise in interest rates is the main driver of the recovery in asset quality, putting the most vulnerable borrowers at greater risk of default. However, it is positive that NLD formation has been limited and is widespread across countries and sectors. At the same time, higher interest rates are boosting profits for many European banks, while their credit-loss absorption capacities are stronger.
Scope believes that NPLs will continue to grow in 2024, but does not think it is realistic to expect them to nearly double to the 3% mark.
There are, after all, several strong arguments pointing to resilient asset quality metrics in the coming year:
• The reversal of the asset quality improvement trend starts from a low point.
• There is no widespread deterioration in asset quality at this point. Focusing on identified pockets of risk such as commercial real estate and corporate credit exposures tends to be granular.
• The economic recovery of the euro area is likely to be moderate, but no recession is forecast. Scope’s forecast for GDP growth is 1.1% in 2024 versus 0.7% in 2023.
• Higher interest rates provide a boost to profit generation and loss absorbing capacity.
Asset quality concerns could worsen in the event of a prolonged period of tight monetary policy. However, Scope does not believe that a repeat of the previous asset quality cycle, with NPLs reaching levels similar to 2015, is a likely scenario.
An improving business environment, better production standards, more prudent credit risk supervision and a positive outlook for inflation are key differentiators compared to a decade ago. Countries that have contributed heavily to NPL accumulation in the past (eg Italy or Greece) will perform well, Scope estimates.
Rising NPLs but stronger capacity to absorb credit losses
Despite the rapid rise in interest rates over the past 18 months or so, the average EU NPL ratio reported by the EBA moved only marginally, by a few basis points, remaining close to 1.8%. In the first nine months of 2023, NPL ratios rose for most major European banks, but the increase was modest. The largest increase was less than 0.5 percentage points and NPL growth was balanced.
Credit risk in the commercial real estate sector has not decreased since our last assessment in May 2023 and remains in focus. Price corrections continue and tighter refinancing terms add pressure. Scope sees the recent insolvency of Austrian company Signa as an extreme rather than typical example of the challenges facing the industry. Banks’ exposures are manageable compared to loss-absorbing capacity.
The loss-absorbing capacity of many banks has grown significantly as net interest income (and therefore operating income) has grown faster than risk costs. This is a positive, albeit temporary, development due to the expected normalization of interest margins. Large banks also tend to show balanced risk-return profiles: those with the highest cost-of-risk-to-total-loans ratios or higher cost-of-risk-to-operating income ratios before impairment still have supportive profitability metrics.
A mildly negative scenario for the banks’ operating conditions
As of June 2022, borrowers in Europe experienced the fastest rise in borrowing costs in a decade. This is the main driver of the continued economic slowdown in 2023-2024. Growth will remain below potential in many countries. As a result, banking conditions will be tougher in 2024, with real GDP growth expectations falling in many countries.
Higher interest rates and tougher macroeconomic conditions translate into lower loan production. Loan portfolios are currently well maintained and this is a key support factor for banks’ profit generation and loss-absorbing capacity, Scope said.
A prolonged period of elevated interest rates is the main risk for retail and corporate borrowers who are already suffering from reduced net disposable income or squeezed profit margins. It will likely put a damper on credit demand, further impact loan production and increase default risk. It will also affect the dynamism of the real estate and construction sectors.
Source OT
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