European banks could face rising bad loans and falling profits over the next few quarters as the economic slowdown in their home markets continuesthe European Banking Authority announced on December 9.
Asset quality and profitability of banks in the European Economic Area improved in the 12 months to June, but there are early signs of stress that are cause for concern, the EBA said in its latest risk assessment report. Higher volumes of loans with lower credit quality could lead to an increase in NPLs or NPLs in the future, while slowing economic growth and some of the negative effects of rising interest rates could hurt bank profits.
The average share of NPLs of the sampled banks improved to 1.8% in June from 2.3% a year earlier. In the same period, total non-performing loans fell to around 370 billion euros from around 445 billion euros, according to EBA data.
however, the macroeconomic deterioration The EBA said the environment was starting to take its toll on the sector. Inflows of bad loans increased by 30% in the first six months of 2022, driven by the impact of the war in Ukraine and a slowdown in GDP growth, the report said.
In addition, the share of Tier 2 loans in the bank’s portfolio reached 9.5% in the second quarter of 2022, the highest level since the introduction of the accounting standard in 2018, the data showed. Loans are categorized as level 2, when their credit quality has significantly deteriorated since initial recognition in the bank’s portfolio.
These developments point to an upcoming rise in NPLs, especially given the gloomy outlook for the EU economy this winter, the EBA said. “[T]The sudden rise in inflation, rising interest rates and the energy crisis, together with heightened geopolitical uncertainty, have increased the downside risks to economic growth,” it said.
The data shows that more than half of the banks in the EBA sample expect asset quality to weaken in their corporate and consumer credit portfolios.
The average return on capital for the sampled banks increased to 7.8% in June from 7.4% a year ago. A key driver of the increase was higher net interest income, or NII, which rose due to interest rate hikes by central banks.
While rising interest rates will continue to support bank profits, some lenders are also likely to feel the negative impact of higher interest rates, the EBA notes. Higher rates, along with lower GDP growth, could lead to a drop in income from wealth management and payment services fees, affecting banks’ profitability. Banks that are more dependent on wholesale funding would also have to deal with sudden funding costs, the EBA said.
An expected macroeconomic slowdown could lead to slower loan growth and rising impairments, while higher inflation could increase operating costs, he said.
Considering this, it remains uncertain how banks’ profitability will develop in the coming months and quarters, according to the EBA.
The report tracked the performance of 122 banks based in the European Economic Area in the second half of 2021 and the first half of 2022 and assessed the potential risks that banks could experience over the next 12 months.