EBA published risk dashboard for the fourth quarter of 2019. The risk dashboard summarizes the main risks and vulnerabilities in the banking sector in EU. Ahead of the COVID-19 crisis, capital ratios and asset quality of banks in EU had improved while the return on equity had further worsened. Looking forward, it is expected that asset quality will deteriorate in the quarters to come, even though extensive monetary and fiscal stimulus programs as well as policy responses such as guidance on debt moratoria might provide some relief to banks and their customers.
The risk dashboard is based on a sample of 147 banks, covering more than 80% of the banking sector (by total assets) in EU, at the highest level of consolidation. The level of risk and short-term outlook presented in the dashboard summarize the probability of the materialization of the risk factors and the likely impact on banks. The assessment takes into consideration the evolution of market and prudential indicators, own assessments of the national supervisory authorities and banks, and analyst views. The short-term outlook presented the dashboard indicates the following with respect to:
- Asset quality. the COVID-19 pandemic has led to sudden supply and demand shocks and deteriorating economic prospects, with the expectation of rising default rates and higher provisioning needs. Banks might focus on managing existing credit lines of potentially distressed borrowers rather than extending new lending.
- Market risk. Further market price corrections and bouts of volatility might follow as the progression of the COVID-19 pandemic and its economic impact are highly uncertain. More volatile financial market can be expected to be susceptible to further underlying geopolitical risks and commodity price corrections. Beyond Europe and the COVID-19 pandemic, interventions of the US-Fed to mitigate bouts of volatility in USD repo and financial markets point to additional persisting underlying risks, and the potential for sudden volatility and illiquidity.
- Liquidity and funding. Favorable funding conditions in the fourth quarter of 2019 further improved until February and led to historically high issuance volumes of unsecured instruments, particularly of MREL/TLAC-eligible bonds. Banks made use of these conditions to pre-fund some of their 2020 funding needs at the lowest pricing levels recorded and amid very strong investor demand. Yet conditions suddenly changed fundamentally with the COVID-19 outbreak in Europe. Ample central bank liquidity facilities, including additional longer-term funding programs and extended USD swap lines central banks launched in Europe and beyond in response to the COVID-19 outbreak, can act as strong backstops. Some challenges for banks to attain longer-term market funding at reasonable costs can be expected while high uncertainties surrounding the COVID-19 pandemic persist and markets stay volatile. Vulnerabilities for liquidity positions and potentially the deposit base of banks particularly affected by deteriorating market- and economic conditions may also arise.
- Profitability. The COVID-19 pandemic has led to supply and demand shocks that are expected to further add to substantial bank profitability challenges. Loan growth might stall and thus affect interest income, while additional monetary stimulus might add further pressure on margins. Fee income might be affected while the prospect of higher provisioning and impairment needs may further affect profitability. The fiscal response of governments, but also supervisory measures to mitigate the impact of the Covid-19 pandemic and pragmatism in the application of the prudential framework, may offer some relief to the challenges banks are facing.
- Operational resilience. The COVID-19 pandemic, with its challenges for business continuity and operational resilience, including susceptibility to cyber-attacks, adds to previously existing operational challenges. Measures to constrain the pandemic may further increase the reliance on and vulnerabilities of Information and Communications Technology, or ICT, systems. They add to challenges of the previously existing risks of cyber security, data breaches, and reliance on third-party providers. Potential challenges to governance structures stemming from AML/CFT risks also remain relevant.
Keywords: Europe, EU, Banking, COVID-19, Risk Dashboard, Credit Risk, IFRS 9, Liquidity Risk, Business Continuity, Cyber Risk, Operational Risk, Profitability, Market Risk, EBA
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