EBA published the risk assessment report on the European banking system, in conjunction with data from the 2020 EU-wide transparency exercise. The risk assessment finds that, despite the COVID-19 shock, banks have maintained solid capital and liquidity ratios and have increased their lending to the real economy. However, economic uncertainty persists, profitability is at record low levels, and there are several early signs for a deterioration in asset quality. EBA highlights that COVID-19 has aggravated the need for measures to reduce operating costs and that the nonperforming loan ratios are stable, but the proportion of Stage 2 and forborne loans is increasing.
The data show that capital and liquidity ratios of well above the regulatory minimum allowed banks to provide necessary financing to non-financial corporations at the beginning of the crisis. Public guarantees and regulatory relief measures helped the common equity tier 1 capital levels to recover from the initial hit after the outbreak of the pandemic, while extraordinary central bank facilities helped banks to maintain ample liquidity buffers despite tensions in wholesale funding markets. However, the leverage ratio fell slightly as total assets grew more than capital. However, asset quality is expected to deteriorate materially over the next quarters. Banks have booked significant provisions on performing loans that have resulted in a material increase in cost of risk. Although nonperforming loan ratios have continued to decline, other asset quality metrics already show signs of deterioration. Loans classified under IFRS 9 stage 2 and forborne exposures have increased markedly. The phasing out of COVID-19-related measures, such as moratoria on loan repayments and public guarantees, will also likely affect asset quality. In the long term, it is noteworthy that, according to an EBA preliminary analysis, more than 50% of exposures to large corporates are to sectors potentially vulnerable to climate risk.
Additionally, operational resilience of banks has been broadly unaffected, despite the challenges posed by COVID-19. Nonetheless, the usage of information and communication technology (ICT) has grown further, increasing technology-related risks. Money laundering cases still pose important legal and reputational risks. The data also show that banks’ structural profitability challenges remain. Low interest rates, which may stay lower for longer than expected prior to the pandemic, and strong competition from both banks and non-banks, like fintech firms, are adding pressure to the core revenues of banks. The recent fall in operating expenses has somewhat offset the pressure on pre-provision profits, yet these costs might bounce back once the pandemic is over. COVID-19 might be the catalyst for many clients to become digital customers, thus increasing branch overcapacity. Banks might opt for merger and acquisition deals to exploit potential cost synergies. In terms of policy implications, the assessment highlights that banks should brace themselves for deterioration in asset quality; banks should take advantage of favorable liquidity windows to advance in their Minimum Requirement for Own Funds and Eligible Liabilities (MREL) build-up; prudent capital distribution policies are still required as bank capital remains under pressure; and COVID-19 crisis has aggravated the need for cost-reduction measures by banks.
The risk assessment report is based on qualitative and quantitative information collected from the EU supervisory reporting, the EBA risk assessment questionnaire (RAQ), market intelligence, and micro-prudential qualitative information. The supervisory reporting data that competent authorities submit to the EBA on a quarterly basis for a sample of 162 banks from 29 European Economic Area countries have been utilized. Based on total assets, this sample covers about 80% of the banking sector in EU.
Keywords: Europe, EU, Banking, COVID-19, Transparency Exercise, Risk Assessment Report, Regulatory Capital, Credit Risk, NPLs, IFRS 9, Basel, Operational Resilience, EBA
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