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    EBA Publishes Risk Dashboard for First Quarter of 2020

    July 30, 2020

    EBA published its risk dashboard for the first quarter of 2020 together with the results of the risk assessment questionnaire. The updated data show that the impact of COVID-19 outbreak was mainly reflected in the contraction of capital ratios and profitability of banks. The non-performing loan ratios of banks remained stable, confirming that the impact of the pandemic on asset quality can be delayed. EBA also published a thematic note on leveraged finance, which highlights that the expansion of this market segment in recent years has come with a significant easing of credit standards.

    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:

    • Asset quality, which is a key concern amid the COVID-19 outbreak, is expected to deteriorate. The impact will depend on composition of banks' loan portfolios, with consumer and SME lending being among the most vulnerable exposures. The impact on asset quality will also depend on how the pandemic unfolds and how quickly stakeholders accommodate to the new situation. The degree to which extensive monetary and fiscal stimulus programs as well as payment moratoria and public guarantee schemes will help to soften the deterioration in asset quality remains to be seen.
    • Markets remain highly vulnerable to further spikes of volatility, as asset price trends appear disconnected from an increasingly adverse economic outlook and from the evolution of the pandemic in relevant economic areas such as the US or Latin America. News related to COVID-19 and political tensions, including an inconclusive end of the Brexit transition period or the resurgence of trade-war related news, may result in severe price corrections and volatility. 
    • Due to the access to central bank funding, refinancing risks seem to be limited. Liquidity risks also seem to be limited. In the mid- to long-term, banks might again face challenges to refinance huge stocks of central bank funding. Small and other more vulnerable institutions might face challenges in accessing primary markets again and in building up MREL buffers.
    • The pressure on profitability, which had already existed before the outbreak of the pandemic increased further and return on equity contracted sharply in the first quarter of 2020. Net interest income will presumably remain under pressure from the low rate environment, which is expected to last even longer than assumed prior to the crisis. As recent growth in loan volumes was strongly driven by government guaranteed loans, which have presumably lower yields, they can only partially compensate for the negative impact on margins. Banks will need to increase ICT investments to address the increasing use of internet-based services by their clients, while mitigating ICT risks. Efforts to reduce branch networks and overhead expenses might speed up, as banks and their clients have been operating seamlessly through digital channels and with reduced availability of physical offices during the confinement.
    • Although banks were broadly successful in containing the immediate impact of the crisis on their operations, they need to be prepared to deal with a different operational environment and the constant threat from a resurgence of COVID-19 outbreak. Following the reopening of the economy, banks will have to further and faster adapt their ICT systems to a challenging technological environment, which could also increase operational risks. These include risks related to cyber security, data breaches, and reliance on third-party providers.

    EBA conducts semi-annual risk assessment questionnaires among banks and market analysts. Fifty banks and ten market analysts responded to the risk assessment questionnaires in Spring 2020. Results of the survey were received in March and April. Some of the respondents prepared their answers at the beginning of the outbreak of COVID-19 in Europe, while others responded at a time when the outbreak was rapidly spreading across Europe. As a result, some banks already partially considered the impact of the pandemic in their responses, whereas others did not. The key topics covered in the questionnaire include asset quality, profitability, fintech, sustainable finance, and operational risk.

    The thematic note on leveraged finance describes the main characteristics of the leveraged finance market and provides a summary of the data collected by EBA in cooperation with competent authorities on the exposures of banks in EU to this market. The note highlights that indebtedness of borrowers has risen materially while loan maintenance covenants have been relaxed. These vulnerabilities and the inherent risks of leveraged finance led to a sharp contraction in the market during the COVID-19 outbreak. As the pandemic and the ensuing economic lockdown impair leveraged borrowers’ capacities to repay their debts, some banks may suffer losses related to the increase in credit risk and from their mark-to-market positions. For a sample of 26 large banks in EU, the overall exposure to leveraged finance amounts to EUR 400 billion (2.5% of their total assets), concentrated in a few large and highly interconnected institutions. The main exposure is through leveraged loans while exposures to high yield bonds and collateralized loan obligations are comparatively small. Banks might also be directly or indirectly exposed to leveraged finance investors to which they provide credit lines or prime brokerage services or to which they have legal or reputational ties.

     

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    Keywords: Europe, EU, Banking, COVID-19, Risk Dashboard, Risk Assessment Questionnaire, Credit Risk, Liquidity Risk, Cyber Risk, Operational Risk, Market Risk, NPL, EBA

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